What’s justified and what’s not in the hype over US technology stocks

While COVID has been a key source of disruption across multiple facets of our lives, the virus-induced effects are a double-edged sword. On the one hand, central bank and government responses to the crisis have incited market exuberance leading to sky-high valuations and overactive investor imagination. On the other hand, these effects have served a useful purpose by accelerating some important business trends that were already underway. We can all agree data proliferation and the continued digitization of the world certainly are not slowing. What that means for our use of technology is clear. What's less clear is which companies will benefit in a sustainable way and which companies will succumb to the nefarious effects of market bubbles.

For long-term investors, it’s important to put money to work where you find a degree of visibility and stability. Therefore, rather than looking for companies that might benefit from a short-term blip, such as a post-COVID return to normal, it’s important to focus on those companies driven by secular trends or with hard-to-penetrate moats—companies that have ample room to grow and can continue to gain market share over the longer term.

Investors should focus on companies that are well positioned regardless of the post-COVID speed to normalization. Teradyne is a semiconductor test equipment maker and, through decades of research and experience, leads the ATE (automatic test equipment) market with a dominant share in semiconductor testing as well as capabilities in systems and wireless testing. Both the increasing complexity of semiconductor chips and the implications on the manufacturing process are supporting sustainable growth in the ATE market, and we believe Teradyne is attractively positioned in the industry after years of consolidation. With its acquisition of Universal Robots in 2015, Teradyne is also the leader in collaborative robots, which is a small but a significant contribution to the growth profile of the company.  

Another example is Synopsys, which has seen its shares climb higher as the need to work faster and cheaper in designing semiconductor chips is complicated by the increasing complexity. Synopsys makes EDA (Electronic Design Automation) software that is an important tool for R&D efforts in the semiconductor industry. From the design of the chip and design of the manufacturing tools to verification of the chip and the associated software that will run on it, Synopsys is just one of a few companies that can fulfill the broad needs of the industry. Its mission critical tools are relied on by engineers for their unending R&D, in good times or bad.

Today is no different from the past with the constant march to be more productive and more efficient. The race to outperform competition continues with the quick adoption of the latest technological tools. We believe Teradyne and Synopsys are two important companies in these times of data and device proliferation that are positioned to do well regardless of which smartphone gains share, which software becomes our workflow platform of choice, or however a company increases automation.

And the race is on for technical capabilities as seen in the semiconductor industry and the geopolitical friction with other countries of the world. Investments in chip design and testing capabilities should continue to be an important priority. There is also concern on the domestic front, with large IT companies having recently attracted greater regulatory scrutiny. Information technology is a naturally consolidating space, and many leading companies, such as Google, hold quasi-monopolistic positions. We believe consumer behavior should drive future growth in IT companies, and we are closely watching how these companies are adding value for their customers. Overall, we do not think investors in US tech should be overly concerned.

Not all tech is the same – be disciplined and selective

The need for certain capabilities (e.g., ability to transact digitally or the need to connect with each other remotely) did accelerate the adoption of various technical tools, and we saw that in the reported sales growth of many companies. But that surge in demand was met by an even greater surge in stock prices, as investors scrambled to get exposure to these COVID-benefiting stocks. The software industry is a case in point where valuations of some of these stocks require a doubling of revenue for each year over the next several years.  

Some argue the market caps of these companies are justified by their robust earnings and cash flow, but that also requires these companies to deliver margins that are near or even above the levels of companies like Adobe, whose industry leading margins are matched only by a few. So, despite intriguing companies with high growth, we agree that there is a lot of frothiness in the market. But not all tech stocks are the same. And some valuations are justified, while some are not. Investors must be mindful of fundamentals and should pay close attention to what they buy and how much they are paying for it.

For example, a company like Keysight offers exposure to the structural trend of more data and more devices. Keysight is a leading test and measurement company with a broad offering of equipment and software for electrical and radio signals that are critical tools for the research, design, and production of today's many technology and devices. Growth is supported by the introduction of 5G itself but also what 5G will be doing for the Internet of Things, AI, auto, and increasingly more applications in this digital age. With 15%+ spend in R&D, we believe Keysight is well positioned to stay ahead of competition with solutions to meet the needs of the highly evolving technology landscape.  

The current climate requires investors to be more discerning. The key is looking to identify businesses that can create their own growth and benefit from secular shifts. Drilling down into company fundamentals and looking for predictable long-term earnings power can help reward investors. It’s important to remain focused on finding the right businesses poised for long-term growth.

Any investments discussed are for illustrative purposes only and there is no assurance that the adviser will make any investments with the same or similar characteristics as any investments presented. The investments are presented for discussion purposes only and are not a reliable indicator of the performance or investment profile of any composite or client account. Further, the reader should not assume that any investments identified were or will be profitable or that any investment recommendations or that investment decisions we make in the future will be profitable.

Certain of the information contained in this presentation is based upon forward-looking statements, information and opinions, including descriptions of anticipated market changes and expectations of future activity. VAMUS believes that such statements, information, and opinions are based upon reasonable estimates and assumptions. However, forward-looking statements, information and opinions are inherently uncertain and actual events or results may differ materially from those reflected in the forward-looking statements. Therefore, undue reliance should not be placed on such forward-looking statements, information and opinions.