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Everything You Need To Know About Investing In Technology

The ASX 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 emerging companies of all sizes, start-ups, and billion-dollar household brands.

In a broad sense, the ASX technology sector includes stocks involved with the research, creation, and distribution of technology-based goods or services. That can be everything from computers to software, televisions to websites. Hardware is the term for the physical device, such as a computer, a television or a smartphone. Software is the term for the computer code, programs and platforms that make those physical devices work.

Article last updated: 29 September 2020

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 quickly, 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 may make a huge splash, only to fade out quickly.

Technology is an exciting space that includes trends from artificial intelligence (AI), to smartphones, blockchain, self-driving technologies, the ongoing trend towards 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 technologies sector, but also consumer electronics, interactive media and services, and health care technology 

You saw the returns that tech shares can bring to a portfolio in good times when stocks are in a bull market. But (as we all know) 2020 has so far been defined by one of the most volatile periods in recent stock market history, which included a short but extremely sharp bear market. Although it isn’t obvious in the numbers now, in the throes of the market crash tech shares were hammered far harder than the broader market.

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!

 

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

All in all, the technology sector can be boom or bust. The same is true of individual companies and market segments within the space. Sometimes a technology seems like it might 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.

Areas for investment 

Technology is a wide-ranging term. It has expanded far beyond what would have once been considered the typical tech stocks like your Apples or Microsofts. It’s not even fair to call any of these brands computer companies anymore. They operate in a variety of other segments that are all part of the technology market, 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, isa type of AI where computers learn without being specifically programmed to. You’re probably familiar with AI systems like Apple’s Siri or Amazon’s Alexa, 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 

While blockchain has gotten a lot of publicity because it’s the technology behind Bitcoin and other virtual currencies, it’s more than just an alternative payment method or a bunch of cryptocurrencies. Blockchain is an area that has been scorned by many investors following the ‘Bitcoin bubble’ of 2017, but its potential applications remain vast. The concept of a blockchain ‘ledger’ – a single, decentralised and incorruptible transactional record – may well be one of enormous future value.

Self-driving technologies 

This is unfortunately not an area in which many ASX companies specialise. But US-based companies like Alphabet subsidiary Waymo, TeslaUber, and most major auto manufacturers are working on creating self-driving cars. In most places, that’s not even legal yet, but some driver-assist technology has already come to market. It’s likely that self-driving cabs and even trucks will be in at least limited use reasonably soon. If (or perhaps when) this does occur, it’s well worth watching this space on the ASX for some Aussie innovation.

Computers and software  

These are the companies that make the laptops, desktops, and tablets, and the software that runs them. This segment also includes component players, but this subsector is dominated by US companies like Intel, which make 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, eBayTwitter, and Facebook 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 everything from a smart thermostat that can adjust the temperature in your home to complex medical equipment that can order its own repairs. 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 – something that every internet-enabled electronic device contains. 

Streaming media 

The first name on every investor’s lips when it comes to media streaming would no doubt be the US behemoth Netflix Inc. – maybe followed by Amazon’s Prime or more recently Walt Disney Co’s Disney+.

But 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 both purchases and creates content for its streaming platform, but it also creates and maintains the digital platform itself.

The cloud  

The cloud is a system of computer storage 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 

With data now housed in the cloud, on our devices, and even in the chips in our credit cards, keeping information secure has become a growing industry. Cybersecurity is about making sure information is only accessible to the people who are supposed to see it. There are no major cybersecurity players on the ASX, but there is a cybersecurity-themed exchange-traded fund with an unforgettable ticker symbol available – the BetaShares Cybersecurity ETF (ASX: HACK).

Technology is everywhere 

You can invest in technology without buying a pure technology-sector stock. 

For example, Coles Group Ltd (ASX COL) has a huge retail 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 the needs of its customers.

ASX blue-chip stalwart Commonwealth Bank of Australia (ASX: CBA) is moving into the payments space with its new Klarna partnership, and in the process blending its old business model with fresh innovation.

Domino’s Pizza Enterprises Ltd (ASX: DMP) is trialling drone technology to help it deliver pizzas to its customers faster and cheaper. Domino’s is far from a ‘tech’ company being in the fast food business. But this doesn’t stop Domino’s and its shareholders from benefiting from the wonders of technology.

Technology has bled into nearly all areas of life, and a number of companies that at first glance are not specifically technology companies – think the automakers developing self-driving cars – are at least partially technology stocks.

A look at technology ETFs 

An exchange-traded fund, or ETF, is a fund that invests in multiple stocks but is sold like a single stock that tracks a certain index and trades on a major stock exchange. It’s a way to own a market sector without having to rely on specific stocks. For example, you might buy an ETF of all 200 shares in the S&P/ASX 200 Index or just a smaller ETF tracking biotech companies.

Just like a mutual fund, an ETF has an expense ratio, meaning that a percentage of the fund’s assets are used to cover management and other costs. The expense ratio includes management fees, advertising fees, and administrative fees. It’s expressed as the percentage of the fund’s assets that are used to cover operating expenses each year. In a broad sense, lower is better, but you should look at overall returns and not just the expense ratio when considering an ETF.

There are some tech ETFs available on the ASX. We’ve already discussed HACK, but you could also look at the ETFS Morningstar Global Technology ETF (ASX: TECH), which tracks a global basket of large-cap tech stocks 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, or the ETFS ROBO Global Robotics and Automation ETF (ASX: ROBO), which follows a basket of AI and robotics-focused companies. There are lots of choices out there!

What metrics matter most? 

There are really two major types of technology companies: developing brands and mature companies. Even 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. That provides long-term revenue stability, allowing these mature companies to develop their next products without having to worry about keeping the lights on.

REA Group for example, has leveraged the vast amount of property data that it has from its enormous customer base and moved sideways in the property market, expanding into property valuation and mortgage broking. 

A mature technology company is valued partly by traditional methods, including profit, revenue growth, and overall sales. Of course, because technology is an ever-changing space, even a company like REA or Nine Entertainment can see its stock 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 potential for sales, not 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.

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

Who should invest in technology? 

Technology stocks offer opportunities for both novice and experienced investors. Companies like Afterpay, Xero, and even smaller players like Pushpay Holdings offer a chance for people to buy shares in companies whose brands have become integral parts 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 a part of the future.

The technology space offers opportunities for both growth investors and income investors, who can choose from several mature, established companies. Of course, because this is a sector that’s rapidly developing, there’s some growth opportunity even in mature companies.

Trying to get a clear picture for the value of a technology stock can be difficult. The products and revenue streams of a technology company 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 stocks aren’t being valued for what the company has already achieved, rather for what it might achieve going forward. These stocks often have 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 at the time of writing, shares were around $74 – making this company a ‘74-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 do you think investors minded? Between 2012 and 2020, the Xero share price rose from around $4.50 to its most recent high of $103.43. The fact that investors are still willing to assign a price-to-earnings (P/E) ratio over 4,200 to Xero even today shows their faith in the company’s growth runway, despite its delayed profitability.

That’s why when you are deciding whether to invest in one of these companies, you should look at valuation and also market potential. There’s no single method for doing that, but you should consider: forward earnings projections, earnings growth rate for calculating forward P/E ratio, and the PEG (price-to-earnings-to-growth) ratio. For growing companies, paying attention to free cash flow and debt will also help investors 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..

That’s at least partly because it makes sense in many cases for technology companies to invest more heavily in research and development than other sectors. The sector also  contains fewer established, mature companies. Over in the US, some tech companies (such as Apple and Microsoft) have reached something close to this description, and as such, have started to pay healthy annual dividends to their investors. This is less the case on the ASX. 

Still, there are some exceptions. Stock market services provider Computershare Limited (ASX: CPU) is one such example. Its share price had recently offered investors a starting yield over 4% per annum. There are dividend-payers in the tech space, but many are still well in the ‘dividend growth’ phase of their life. I like to think of it as a space to find a future dividend blue-chip!

Top technology stocks

As noted above, it’s not easy to nail down exactly what a technology stock is. Most of these companies are clearly tech companies, but Xero and Zip Co could arguably be considered a services company and a financial company, respectively.

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 stocks are something of an ASX answer to the US FAANG group (Facebook, Apple, Amazon, Netflix and Alphabet (Google)).

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 (including by 23% and 17% respectively, in FY2020), assisted by the company’s aggressive bolt-on acquisitions strategy. 

Although WiseTech has run into a few turnstyles this year (not least of them being the coronavirus), there’s no doubt this company has an exciting future ahead of it!

Altium Limited (ASX: ALU)

As discussed earlier, Altium markets its self-titled ‘Altium Designer’ software that 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. It has also been extremely successful in building a decent chunk of market share for Designer 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. And all of the ‘trends of the future’ we have discussed today – whether it be AI, self-driving or the Internet of Things – will be leaning on printed circuit boards as a foundation upon which to build. 

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

Appen Ltd (ASX: APX)

Our third WAAAXer stock is Appen – the aforementioned dataset provider. Appen notoriously keeps 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. And it’s not just the FAANG stocks either. Companies from Tesla and NVIDIA to Uber and IBM are speculated to have come to the company’s door. Maybe we’ll know for certain one day.

What is certain is this company’s continuing growth potential. Ever wondered how Apple’s Siri or Microsoft’s Cortana went from barely being able to understand speech a few years ago to now being able to almost have a full, semi-normal conversation? Well, it’s partly because of the work Appen does. 

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

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 us. Thus, Appen is one of the most exciting companies on the ASX, and one that is actively shaping the technology of tomorrow.

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 have been priced at $30, $40 back down to $8 and then back up to $40, then up to $60, then $80, then $95.97 (its current all-time high). It’s been a wild ride to watch, to say the least.

But that’s because Afterpay has had its fair share of bulls and bears, and seems to prove the bears wrong every time. It was the pioneer of the whole ‘buy-now, pay-later’ concept, which has turned into one of the greatest ASX success stories of recent times. It was originally thought that (like so many tech pioneers) it would be overtaken by a newer competitor that did what Afterpay does, but better.

Turns out consumers still love Afterpay and its now-powerful brand.

Then it was 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 first the US, then Britain. 

Investors have recently learned that Chinese tech giant Tencent Holdings has bought a substantial stake in the company. This has boosted investor confidence in Afterpay to new heights, despite the lockdowns of the coronavirus, although this has cooled yet again with news of increasing participation in the BNPL market by US giants like PayPal, as well as from our own ASX banks. The least we can say is Afterpay is certainly a stock to watch (and underestimate at your peril!).

Xero Limited (ASX: XRO)

The final WAAAX stock is of course Xero. Xero is another SaaS giant of the ASX, but on the surface, its core business doesn’t seem nearly as interesting as Altium’s. Xero initially provided its accounting software as a solution to the bookkeeping needs of small-to-medium-sized businesses, after founder Rod Drury noticed how difficult it was for small businesses to do their books – and how much of a dreaded task for these business owners it was. Thus, Xero was born.

Xero is at its core a New Zealand company – listing in Auckland in 2007 and only on the ASX in 2012. But despite this major setback (I kid 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 over 2.28 million) over the 2020 financial year. What’s more, these customers are highly sticky. Accounting, payroll and tax are necessities for a business, and if you like the product you use for these (which most do), why stop? It’s Xero’s mission to make sure the process is as painless and ‘beautiful’ as possible. 

Xero has yet another almost endless runway in front of it. Businesses all over the world do bookkeeping and have tax obligations at very frequent (and compulsory) intervals. Many countries are even pushing to make managing these affairs through an online channel like Xero mandatory. 

If Xero can keep up its stellar momentum, this could be an SaaS giant of the ASX one day.

Carsales.com Ltd (ASX: CAR)

Our first non-WAAAX stock is this online classifieds giant. Carsales is another Aussie tech company that has come to dominate its market and is now one of the highest automotive classifieds companies in the world. It also happens to be one of the rare stocks whose name 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.

It also has an almost comically large and thorough range of other online marketplaces, ranging from boatsales.com.au, trucksales.com.au and bikesales.com.au to constructionsales.com.au, caravancampingsales.com.au and farmmachinerysales.com.au.

This company benefits enormously from its ‘network’ effect. Customers know that it’s the largest and most comprehensive place to find the vehicle they’re looking for, or else sell their vehicle to the person who wants to buy it the most. As more people come to this realisation, more customers are drawn in and the more 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 may 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. 

But that’s where Pushpay sees an opportunity. This company has developed a ‘donor management system’ which allows digital donations management, as well as other financial tools, for faith-based, community and non-profit organisations. It aims to be the modern equivalent to the old ‘hat being passed around the church’. 

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

Kogan.com Ltd (ASX :KGN)

Often described as Australia’s answer to Amazon, we have here our last stock: Kogan.

Named for its eccentric-but-brilliant CEO Ruslan Kogan, this company is now one of Australia’s largest online marketplaces. It initially stuck to the electronics side of things, selling TVs, computer accessories and mobile phones. But Kogan’s low-cost business model has enabled the company’s wild success, and it now offers everything from superannuation services to credit cards and electricity provision. 

Kogan is a company that, at its core, leverages the full powers of the internet – which makes it a phenomenal company to have owned over the past few years. Since its IPO in 2016 (for around $1.50 a share), it has grown to over $20 a share. It has withstood a furious onslaught of competition, going up against everything from eBay and Amazon to Gumtree and the bevy of Aussie retailers it also jostles against. 

With its founder still at the helm, it’s clear that Kogan has the secret sauce to thrive as an online retailer, and will likely continue to innovate in its existing areas as well as even more new avenues in the coming years.

Figures correct at 17 September 2020. Sebastian Bowen contributed to this report and as of 17 September 2020 owns shares of Alphabet (Class A), Uber, Tesla, Facebook and Disney. 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. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Apple, Facebook, Microsoft, Netflix, Tesla, and Walt Disney. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. owns shares of ETFS Morningstar Global Technology ETF, MEGAPORT FPO, and ZIPCOLTD FPO. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. recommends Adobe Systems and Uber Technologies and recommends the following options: long January 2021 $60 calls on Walt Disney, long January 2021 $85 calls on Microsoft, short January 2021 $115 calls on Microsoft, and short July 2020 $115 calls on Walt Disney. The Motley Fool Australia owns shares of and has recommended Kogan.com ltd and PUSHPAY FPO NZX. The Motley Fool Australia owns shares of AFTERPAY T FPO, Altium, Appen Ltd, BETA CYBER ETF UNITS, COLESGROUP DEF SET, WiseTech Global, Woolworths Limited, and Xero. The Motley Fool Australia has recommended Adobe Systems, Alphabet (A shares), Alphabet (C shares), Apple, carsales.com Limited, Domino’s Pizza Enterprises Limited, Facebook, MEGAPORT FPO, Netflix, Nine Entertainment Co. Holdings Limited, REA Group Limited, and Walt Disney. 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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