Everything You Need To Know About Investing In Technology

Everything You Need To Know About Investing In Technology

The ASX Information Technology sector includes everything from major companies that everyone knows, to players both big and small that operate largely behind the scenes. The ‘tech sector’ is also home to start-ups, emerging companies of all sizes, and billion dollar household brands.

In a broad sense, the ASX technology sector comprises companies involved in the research, creation, and distribution of technology-based goods or services. That’s everything from computers to software and televisions to websites. 

‘Hardware’ is the term for a physical technology device, such as a computer, television or smartphone. ‘Software’ is the term for the computer codes, programs and platforms that make those physical devices work.

Article last updated: 23 June 2021

About ASX Technology Shares

ASX technology shares offer investors a lot of opportunities. In fact, the sector has comfortably outperformed (including dividend returns) the S&P/ASX 200 Index (ASX: XJO) over the last one-, three- and five-years, as you can see in the table below:

Chart: author’s own. Data Source: asx.com.au, S&P Global

Those strong returns, however, do not mean the technology sector is without risks. 

Technology changes rapidly, and one-time leaders can quickly fall behind or even go out of business. Remember Kodak? Remember Blockbuster Video? These companies were once at the forefront of technology within their industries, only to be brutally supplanted and made redundant by technological change.

In addition, promising emerging companies might make a huge splash initially, only to fade out quickly.

Technology is an exciting space that encompasses trends such as social media, artificial intelligence (AI), smartphones, blockchain, self-driving technologies, software-as-a-service (SaaS), the Internet of Things (IoT), streaming media services, and more. It’s an area full of innovation and opportunity, but also some risk.

Tech can be volatile 

On the ASX, the tech sector is best represented by the ASX All Technology Index (ASX: XTX), a relatively new index that tracks not just the Information Technology sector but also consumer electronics, interactive media and services, and healthcare technology. 

You've no doubt heard about the spectacular returns that tech shares can bring to a portfolio in good times when we’re in a bull market. But things can change. 

As we all know, 2020 was defined by one of the most volatile periods in stock market history due to a black swan event that led to a short but extremely sharp bear market

In the throes of the crash, tech shares were hammered far harder than the broader market. This was largely due to the relatively expensive nature of the sector for investors relying on traditional methods of stock evaluation, such as the price to earnings ratio

In times of panic, many investors ‘flock to safety’ and move their investments to large cap stocks with long standing track records for delivering profits. 

Technology companies also skew younger than average and many are yet to make a profit. This makes them susceptible to volatility, especially in unprecedented times or when investors are feeling nervous. 

Tech shares can often underperform the broader market when there is significant selling pressure. Investors who are interested in tech shares should keep this in mind. 

However, such falls can be reversed extremely quickly. When we look back at what happened immediately after the 2020 market sell-off bottomed in March, we see a steep recovery for tech stocks with a huge 39% gain in just six months for the ASX All Technology Index.

 

S&P/ASX 200 Index

ASX All Technology Index

1 Month

2.73%

13.27%

3 Months

5.94%

23.85%

6 Months

-4.70%

39.07%

Chart: author’s own. Data source: BetaShares.com.au – as of 17 September 2020

This reversal of fortunes for the tech industry was largely due to investors quickly gaining clarity around which industries could weather the storm of the pandemic. In such a unique time of threat, technology will historically be seen as one of the industries that benefitted from the forced changes in our day-to-day lives.

The technology sector can boom and bust. The same is true of individual companies and market segments within the space because it is a rapidly evolving industry with advancements made in short timeframes. 

Sometimes, a new technology product or service might appear to be ‘the next big thing’ – think 3D television or 3D printing just a few years ago – only for it to fail spectacularly in the marketplace due to a superseder.

Areas for investment 

Technology is a wide-ranging term. It has expanded far beyond what would have once been considered the typical tech shares like Apple Inc (NASDAQ: AAPL) or Microsoft Corporation (NASDAQ: MSFT).

Tech companies operate in a variety of market segments that are all part of the broader technology sector, including but not limited to:

Artificial intelligence (AI) 

This is where computers perform tasks that might have traditionally required a human brain. AI also encompasses deep learning and machine learning. 

Deep learning involves data scientists building computer models inspired by the structure and function of the human brain that essentially reproduce our ability to learn. 

Machine learning, by contrast, is a type of AI where computers learn without being specifically programmed to do so. You’re probably familiar with AI systems like Siri from Apple (NASDAQ: AAPL) or Alexa from Amazon.com Inc (NASDAQ: AMZN), but you might not be aware that systems like these are fuelled by the valuable data that ASX company, Appen Ltd (ASX: APX) provides.

Payments 

Payments is one of the areas that has attracted the most innovation over the last decade. As cash and cheques have become increasingly unpopular, a raft of ASX companies have tried to make their mark on a future without cash. Afterpay Ltd (ASX: APT) is the most well-known ASX company in this space, but we also have other contenders like Zip Co Ltd (ASX: Z1P), Pushpay Holdings Ltd (ASX: PPH) and Splitit Ltd (ASX: SPT).

Blockchain 

Blockchain has received a lot of publicity because it’s the technology behind Bitcoin and other virtual currencies. It was scorned by many investors following the ‘Bitcoin bubble’ of 2017.

However, Blockchain has many other potential applications. The concept of a blockchain ‘ledger’ – a single, decentralised and incorruptible transactional record – might well be one of enormous future value.

Self-driving technologies 

This is not an area in which many ASX companies specialise. But US-based companies like Alphabet Inc (NASDAQ: GOOGL) and subsidiary Waymo, Tesla Inc (NASDAQ: TSLA), Uber Technologies Inc (NYSE: UBER), and most major car manufacturers are working on creating self-driving cars. 

Some driver-assist technology has already come onto the market and it’s possible that self-driving cabs, and even trucks, will be in limited use reasonably soon.

Computers and software  

These are the companies that make the laptops, desktops and tablets as well as the software that runs them. This segment also includes component players but is dominated by US giants like Intel Corporation (NASDAQ: INTC), which makes the chips and processors that power computers, along with bigger well-known brands like Apple and Microsoft.

Xero Limited (ASX: XRO) is a nice contrast. It is a software company that markets its cloud-based accounting solutions in a software-as-a-service (SaaS) subscription model.

The internet 

Normally, you would think of US companies like Alphabet’s Google, Amazon, eBay Inc (NASDAQ: EBAY), Twitter Inc (NYSE: TWTR), and Facebook Inc (NASDAQ: FB) if someone mentioned ‘internet companies’. But the ASX has a few shining lights of its own, including Carsales.com Ltd (ASX: CAR) and REA Group Ltd (ASX: REA)

Most of these players are at least partially supported by advertising revenue, though some sell subscriptions and monetise in other ways.

The Internet of Things (IoT) 

The IoT is the network of devices connected to each other and the cloud – the public internet that allows for links between far-flung systems. 

It’s involved in everything from a smart thermostat that can automatically adjust the temperature in your home to complex medical equipment that can order their own repairs. The agricultural industry is also benefiting from the rise of IoT. ‘Smart sensors’ are being used to detect soil conditions, and automated machinery can treat crops based on those soil conditions.

Altium Limited (ASX: ALU) is the ASX share that perhaps stands to benefit most from the IoT. Altium makes software that assists in the design and manufacture of electronic circuit boards, which are components required in every internet-enabled electronic device.

Streaming media 

The first name that comes to mind is US behemoth Netflix Inc (NASDAQ: NFLX), perhaps followed by Amazon Prime or more recently, Disney+ from Walt Disney Co (NYSE: DIS).

Here in Australia, we have our own homegrown streaming service Stan, owned by Nine Entertainment Co Holdings Ltd (ASX: NEC). Stan and its American compatriots are entertainment companies, but they are also technology companies that have created their own digital infrastructure. Stan purchases and creates content for its streaming platform, and also develops and maintains the digital platform itself.

Cloud computing  

‘The cloud’ is a familiar term given to computerised storage infrastructure that allows information and services to be accessed by devices from anywhere. The cloud allows companies (and individuals) to use services that are not resident in their devices. NextDC Ltd (ASX: NXT) and Megaport Ltd (ASX: MP1) are major ASX cloud service companies.

Cybersecurity 

Cybersecurity is about making sure information is only accessible to the people who are supposed to see it. With data now housed in the cloud, on our devices, and even in the chips on our credit cards, keeping information secure has become a growing industry. 

There are no major cybersecurity players on the ASX, but there is a cybersecurity-themed exchange traded fund (ETF) with an unforgettable ticker available – the BetaShares Global Cybersecurity ETF (ASX: HACK). More on ETFs later.

Technology is everywhere 

You can invest in technology without buying a pure Information Technology sector stock. Technology has bled into nearly all areas of life, so you could argue that many non-tech companies have morphed into partial-tech stocks because so many of them are using technology to grow. 

For example, Coles Group Ltd (ASX: COL) has a huge retail shopfront presence in Australia, but it is also investing billions into supply chain automation and logistical technology. The supermarket giant is using innovation to lower its costs and increase its responsiveness to customer needs.

ASX blue chip stalwart, Commonwealth Bank of Australia (ASX: CBA) is moving into the payments space with its new Klarna partnership.

Domino’s Pizza Enterprises Ltd. (ASX: DMP) is trialling drone technology to deliver pizzas to its customers faster and more cheaply.

A look at technology ETFs 

An exchange traded fund, or ETF, is a fund that invests in multiple shares but is sold like a single share on the ASX. 

Most ETFs track a certain index, so they provide a way to own an entire market sector without having to purchase every stock individually. 

For example, you might buy an ETF of all 200 shares in the S&P/ASX 200 Index, or a smaller ETF tracking biotech companies.

Just like a mutual fund, an ETF has an expense ratio, which is the percentage of the fund’s assets used to cover management fees, advertising fees, and administrative fees. In a broad sense, lower is better but you should look at overall returns, not just the expense ratio, when considering an ETF.

There are several tech ETFs available on the ASX. We’ve already discussed HACK, but other examples include the Morningstar Global Technology ETF (ASX: TECH), which tracks a global basket of large cap tech shares like Netflix and Alphabet. 

There’s also the BetaShares S&P/ASX Australian Technology ETF (ASX: ATEC), which simply tracks every share in the ASX All Technology Index. 

The ROBO Global Robotics and Automation ETF (ASX: ROBO) follows a basket of AI and robotics-focused companies. 

There are lots of choices out there!

What metrics matter most? 

Technology companies typically fall into two baskets – developing brands and mature companies. 

Mature companies like Nine Entertainment or REA Group still have to innovate to survive in the long term, but they have a base of products that have become entrenched in the market. This provides long term revenue stability, which allows them to develop their next products without having to worry about how to keep the lights on.

REA Group, for example, has leveraged the vast amount of property data collected from its enormous customer base to expand into property valuation and mortgage broking. 

A mature technology company is valued partly through traditional methods, including profit, revenue growth, and overall sales. Of course, because technology is an ever-changing space, even a company like REA can see its share price rise or fall based on an unproven product, or even an announcement of a new development.

Developing brands like Afterpay face a different challenge. These are companies valued largely on their sales growth and future potential, not current profit. 

Afterpay, for example, has impressed investors time and time again with its rising sales volumes and expanding geographic footprint, but it has yet to show it can operate profitably.

Developing brands generally have more upside (at least at first), but they come with significant risk.

Who should invest in technology? 

Technology shares offer opportunities for both novice and experienced investors. Companies like Afterpay, Xero, and even smaller players like Pushpay offer investors the chance to buy shares in companies whose brands have become an integral part of their lives. 

It’s also a space where the average person can jump on an emerging technology that they have experienced and believe will become part of the future.

Technology shares offer opportunities for both growth investors and income investors, who can choose from several mature, established companies. Of course, this is a sector that’s rapidly developing, so there’s usually some growth prospects even in mature companies.

Trying to get a clear picture of the value of a technology share can be difficult. The products and revenue streams can be more complex than a consumer goods company, for instance, like Woolworths Group Ltd (ASX: WOW), which sells brands and products most of us are familiar with. 

Companies can also be valued using a number of methods, including earnings-based valuations, revenue-based valuations, cash flow-based valuations, equity-based valuations, and member-based valuations.

Growth investors might like… 

Growth investing is buying shares in companies that you expect will grow a lot in the future. You often pay a premium for them but these shares aren’t being valued on what the company has already achieved, rather for what it might achieve going forward. These stocks often receive a lot of analyst attention, sometimes belying the actual size of the company.

Of course, getting in early on a stock can bring tremendous returns. Afterpay, for example, priced its initial public offering (IPO) at $1. It’s been a volatile ride since (to say the least) but in February 2021, Afterpay shares hit a peak of just over $160, making this company a ‘160 bagger’ in just 4 years.

Another interesting case to consider is that of Xero. This company has been listed on the ASX since 2012 and has been in full ‘growth’ mode ever since. Only recently has Xero started to turn a profit but investors were willing to wait. 

Between 2012 and early February 2021, the Xero share price rose from about $4.50 to a 52-week high of $157.99. The fact that investors were willing to assign a price-to-earnings (P/E) ratio above 500 to Xero shows their faith in the company’s growth runway, despite its delayed profitability.

This is why you should look at both valuation and market potential when deciding whether to invest in one of these companies. 

There’s no single method for doing this but you should consider forward earnings projections, the earnings growth rate for calculating forward P/E ratio, and the price-to-earnings-to-growth (PEG) ratio. 

For growing companies, pay attention to free cash flow and debt to get a better picture of the overall financial health of the business.

Dividend investors might like… 

Here in Australia, the tech sector is not one that is well known for its dividend strength. This is because we have more developing brands and fewer established, mature tech companies. It makes more sense in many cases for younger technology companies to invest free cash in research and development instead of distributing dividends.

Over in the US, established tech companies like Apple and Microsoft have started paying healthy annual dividends to their investors.

Still, there are some exceptions. ASX stock market services provider, Computershare Ltd (ASX: CPU) was founded in 1978 and listed on the ASX in 1994. It began paying dividends in 2019. In June 2021, it was offering a fully franked dividend yield of 2.64%.

Top technology shares

As noted above, there are only a few pure play technology stocks on the ASX. Many companies that are included in the ASX Information Technology sector combine technology with other services. For example, Xero is also a services company and Zip Co is also a financial or payments company.  

Here is a brief summary of some of the big names you are likely to come across in your research of ASX technology shares.

WiseTech Global Ltd (ASX: WTC)

This company is a member of the ASX tech scene’s hottest club – the WAAAXers. Along with Appen, Altium, Afterpay and Xero, the WAAAX shares have been described as Australia’s answer to the US FAANG group (Facebook, Apple, Amazon, Netflix and Google (whose parent company is Alphabet).

WiseTech is a logistics specialist. Its flagship software, CargoWise is designed as an ‘all solution’ platform that assists global logistics operations like customs and trade. 

It has been furiously growing both revenues and earnings in recent years (23% and 17% respectively in FY2020), assisted by the company’s aggressive bolt-on acquisitions strategy.

Altium Limited (ASX: ALU)

As discussed earlier, Altium’s self-titled ‘Altium Designer’ software aims to assist electrical engineers in the design and production of electronic circuit boards. 

It’s a true cloud-based SaaS company, with use of Altium Designer restricted to a pay-per-month subscription model over the cloud. 

This mirrors the successful strategy of US-based Adobe Inc (NASDAQ: ADBE). Altium has already built a decent chunk of market share in this extremely niche area. 

Printed circuit boards fuel the modern innovation cycle. Every new electronic device designed anywhere in the world will likely require a unique printed circuit board. 

All of the ‘trends of the future’ that we have discussed today – AI, self-driving, the Internet of Things and so on – are leaning on printed circuit boards as a foundation upon which to build. 

This means Altium’s software is an evergreen commodity for the company – and one with virtually limitless potential. That’s why Altium has been one of the best ASX tech shares to own in recent years, and what makes it one of the ASX’s biggest tech stars.

Appen Ltd (ASX: APX)

Our third WAAAXer share is Appen, the aforementioned dataset provider. 

Appen produces research and data used for machine learning and AI. The company is a global leader in the development of these human-annotated datasets, which other tech companies use to help their machines learn from us humans better.

Ever wondered how Apple’s Siri or Microsoft’s Cortana went from barely understanding speech a few years ago to now being able to have a full, semi-normal conversation? Well, it’s partly because of the work Appen does. 

The trend towards voice-assisted software is undeniable (it seems every device can talk to us these days!). It isn’t difficult to conceive of a world where everything from your car to your refrigerator can hold a conversation with you. 

Appen is known for keeping its list of clients secret, but there are enough rumours going around to suggest most of the FAANG stocks, like Alphabet and Amazon, have engaged Appen’s services at least once. 

There is also speculation that Tesla, NVIDIA (NASDAQ:NVDA), Uber and IBM (NYSE:IBM) have also come to the company’s door, too.

Afterpay Ltd (ASX: APT)

Afterpay holds the distinction of being one of the most volatile shares on the ASX in recent years. In 2020 alone, Afterpay shares were priced at $30, then $40, then back down to $8 during the COVID crash, then back up to $40, then $60, then $80, then around $120 by the end of the year. 

This momentum continued into 2021, with the Afterpay share price hitting a new, all-time high of $160.05 in February, before falling again. By late June, it was trading at about $122.00. It’s been a wild ride, to say the least.

Afterpay is the pioneer of the whole ‘buy-now, pay-later’ concept, which has turned into one of the greatest ASX success stories in recent times. 

Many originally thought that, like so many tech pioneers, Afterpay would be overtaken by a new competitor that did what it does, but better. Those competitors have emerged (think Zip and Splitit) but consumers still love Afterpay and its now powerful brand.

It was also assumed that Afterpay would never be able to conquer that breaker of ASX hearts – overseas markets. But the company did just that, rapidly establishing expanding beachheads in the US, then Britain. 

In 2020, Chinese tech giant, Tencent Holdings bought a substantial stake in the company. This boosted investor confidence in Afterpay to new heights, despite increasing participation in the BNPL market by US giants like PayPal (NASDAQ:PYPL), as well as our own ASX banks.

Xero Limited (ASX: XRO)

The final WAAAX stock is Xero, another SaaS giant of the ASX, which offers online accounting software services to small and medium-sized businesses.

Xero was born after its founder, Rod Drury noticed how difficult it was for small businesses to do their books – and how much of a dreaded task this was for owners!

At its core, Xero is a New Zealand company, listing in Auckland in 2007 and on the ASX in 2012. Despite this setback (just kidding, of course), Xero has become an ASX powerhouse.

It has been growing its customer base at a truly remarkable speed, posting a 26% rise in subscribers (to more than 2.28 million) over the 2020 financial year. 

What’s more, these customers are highly sticky. Accounting, payroll and tax planning are necessities for a business, and if you like the product you’re using, why stop? It’s Xero’s mission to make sure the process is as painless and ‘beautiful’ as possible. 

Xero has a seemingly endless runway in front of it. Many countries are even pushing to make it mandatory for businesses to manage their bookkeeping and tax obligations through online channels like Xero.

Carsales.com Ltd (ASX: CAR)

Online classifieds giant, Carsales is another Aussie tech company that has come to dominate its market and is now one of the leading automotive classifieds companies in the world. 

It’s also one of those rare stocks with a name that tells you exactly what the company does! 

The company’s flagship website (you guessed it) carsales.com.au is Australia’s largest car sales marketplace. Customers can buy new or used cars, as well as sell their own vehicles in a seamless manner.

The company also owns a large range of other online marketplaces, including boatsales.com.au, trucksales.com.au, bikesales.com.au, constructionsales.com.au, caravancampingsales.com.au and farmmachinerysales.com.au.

This company benefits enormously from its ‘network effect’. As Carsales grows its presence in the market, it attracts more buyers to the site. As Carsales increasingly becomes the ‘go to’ marketplace for car sellers to find buyers, they’re more likely to choose Carsales to assist with the sale. 

We then see a ‘flywheel effect’ as this growth in car supply encourages more buyers to visit the marketplace, and the network effect compounds.    

Carsales was one of the first truly successful ASX tech companies. If you’re looking for a tech share with more of a blue chip feel, this is it.

PushPay Holdings Ltd (ASX: PPH)

Pushpay is another tech company in the payments space, but it’s a very different beast to the formerly discussed Afterpay.

The trend towards a cashless society might bring many benefits to consumers, but it is also not without some disadvantages. Just think of how many charities, street vendors and disadvantaged people rely on small cash payments in their day-to-day lives – something at risk as more and more people leave their cash at home, or in the bank. 

That’s where Pushpay sees an opportunity. This company has developed a ‘donor management system’ that allows faith-based, community and non-profit organisations to receive and manage digital donations.. It aims to be the modern equivalent to the old ‘hat being passed around the church’. 

Due to the coronavirus, the transition towards a cashless society is accelerating. Therefore, Pushpay is sitting in a very powerful tailwind and is another ASX tech share that appears to have a lot of future potential.

Kogan.com Ltd (ASX :KGN)

Often described as Australia’s answer to Amazon, Kogan is named after its eccentric but brilliant CEO, Ruslan Kogan, and is now one of Australia’s largest online marketplaces. 

Initially, it stuck to the electronics side of things, selling TVs, computer accessories and mobile phones. Its low cost business model enabled wild success, and it now offers everything from superannuation services to credit cards and electricity provision. 

At its IPO in 2016, Kogan was valued just above $1.50 a share. By early 2020, it was trading about $7.40 before the COVID crash sent its share price down to about $4.15 in early March. 

It then did a complete about face and became one of the biggest success stories of the pandemic, rising spectacularly to a peak of $25.57 in October. Sales surged as people spent more time at home and online, with spare cash to spend given holidays and travel were off the cards.

It has withstood strong competition, going up against everything from eBay and Amazon to Gumtree and the bevy of Aussie retailers with their own online shopping platforms. 

Figures correct at 23 June 2021.John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool's board of directors. Motley Fool contributor Sebastian Bowen owns shares of Alphabet (A shares), Facebook, IBM, Intel, Tesla, Uber Technologies, and Walt Disney. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of and has recommended AFTERPAY T FPO, Alphabet (A shares), Alphabet (C shares), Altium, Amazon, Appen Ltd, Apple, BETA CYBER ETF UNITS, ETFS Morningstar Global Technology ETF, Facebook, Kogan.com ltd, MEGAPORT FPO, Microsoft, NVIDIA, Netflix, PUSHPAY FPO NZX, PayPal Holdings, Tesla, Twitter, Walt Disney, WiseTech Global, Xero, and ZIPCOLTD FPO. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has recommended Adobe Systems, Intel, Uber Technologies, and eBay and has recommended the following options: long January 2022 $1,920 calls on Amazon, long January 2022 $75 calls on PayPal Holdings, long January 2023 $57.50 calls on Intel, long March 2023 $120 calls on Apple, short January 2022 $1,940 calls on Amazon, short January 2023 $57.50 puts on Intel, short June 2021 $65 calls on eBay, and short March 2023 $130 calls on Apple. The Motley Fool Australia owns shares of and has recommended AFTERPAY T FPO, Altium, Appen Ltd, BETA CYBER ETF UNITS, COLESGROUP DEF SET, Kogan.com ltd, PUSHPAY FPO NZX, WiseTech Global, and Xero. The Motley Fool Australia has recommended Adobe Systems, Alphabet (A shares), Alphabet (C shares), Amazon, Apple, Dominos Pizza Enterprises Limited, Facebook, MEGAPORT FPO, NVIDIA, Netflix, PayPal Holdings, REA Group Limited, Walt Disney, and carsales.com Limited. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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