High-growth technology shares have been excessively oversold and there's now a very small window to take advantage.
That's according to Frazis Capital Partners portfolio manager Michael Frazis, who said mutual funds are now "chronically underweight" on tech.
"Fund managers are now overexposed to late cyclicals," he said in a memo to clients.
"Professionals have swung from overallocated to technology to underallocated."
He took the example of this week's suggestion from the US Federal Reserve that interest rises could come sooner than previously expected.
"[It] was met with a rally in growth stocks," said Frazis.
"The market is crowded on the other side of the trade, whatever 'crowded' means."
Punters often ask Frazis when's a good time to buy. He usually avoids answering, but couldn't help himself this time.
He noted, however, the opportunity is only fleeting.
"This looks like a decent setup. It's rare that investing in technology is a contrarian thing to do, and these moments can pass quickly."
Long-term growth rubs out share price corrections
There are many reasons Frazis is confident about the explosive-growth shares held in his fund.
Firstly, he noted, long-term growth will effectively rub out a temporary price correction.
"In fact, stocks can suffer a material 75% multiple contraction and still post exceptional long term returns," he said.
"When modelling each portfolio company, we assume a substantial multiple contraction and slow-down in growth."
| Internal rate of return | ||||||
|---|---|---|---|---|---|---|
| 10-year growth rate | ||||||
|
Enterprise value |
0% | 10% | 20% | 30% | 40% | 50% |
| (75%) | (4%) | 4% | 13% | 22% | 31% | |
| (50%) | 3% | 12% | 21% | 31% | 40% | |
| (25%) | 7% | 17% | 26% | 36% | 46% | |
| Source: Michael Frazis; Table created by author | ||||||
Regarding the prospect of rising inflation, Frazis claimed his stocks have "exceptional" pricing power.
"E-commerce platforms obviously transfer price increases through directly. But there's something more interesting going on," he said.
"The coronavirus e-commerce boom of 2020 has morphed into a broader consumer boom. In the United States, people are selling second-hand cars for more than they bought them new. I can't remember even reading about a situation like that."
How about higher input and labour costs?
Higher commodity input prices are a small part of tech and pharmaceutical companies, so inflation doesn't whack them as hard as other sectors.
"Think of a heavily leveraged factory employing thousands of workers, that converts steel and raw materials into widgets for other factories higher in the supply chain. That is where inflation hurts," said Frazis.
"Ironically it is precisely those kinds of companies that have outperformed recently."
Frazis admitted higher inflation would see wages rise.
"Staff costs are very relevant for technology companies, but the high cost of each employee is more than matched by efficiency," he said.
"A salesperson or software engineer can generate very significant revenue compared to say, a retail or factory worker."
