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Why tech shares are such attractive investments

There are few industries that, across the the whole sector, seem to have an advantage compared to most other industries. Healthcare shares are seen as both defensive and growth due to the ageing demographics.

The technology sector is a special one to consider in my opinion. ‘Technology’ alone sounds sexy compared to supermarkets or banks.

Venture capitalists love technology because of how capital-light the industry is. A hundred years ago it would take large amounts of money to build factories, warehouses and freight capabilities.

For a decent technology start up all you need is a person with a good idea, a good computer and the computer programming / software skills to create the technology.

Once the software is created there isn’t much more to shell out on capital expenditure – the business just has to become breakeven as fast as possible.

Most software businesses have such high gross margins that each additional ‘unit’ of software sold mostly falls to the bottom line. When you have software businesses that have recurring revenue they become quite defensive if they’re essential software such as Xero Limited (ASX: XRO) or Gentrack Group Ltd (ASX: GTK).

If a business has a unique piece of software and regularly makes updates to it then it can keep raising the price over time each year because it offers a better product. For example, Xero and Altium Limited (ASX: ALU) keep updating their software.

When you combine all of the above factors and add in a potentially global addressable market you may see truly wonderful businesses grow. That’s why Xero, Altium and Gentrack are globally respected and are winning clients in other countries.

Foolish takeaway

However, no business is a buy at any price and many of the technology shares have reached astronomical valuations which may fall over the next year or two. For the ultra-long-term, Altium looks like it has a very promising future.

However, at today’s value I’d say Citadel Group Ltd (ASX: CGL) at just over 22x FY19’s estimated earnings looks quite attractive in the technology space.

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Motley Fool contributor Tristan Harrison owns shares of Altium. The Motley Fool Australia owns shares of Altium, Citadel Group Ltd, and Xero. The Motley Fool Australia has recommended GENTRACK FPO NZ. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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