MARKET COMMENTARY

US Tech Stocks: Seeing Beyond the Obvious

Franklin’s Jonathan Curtis and Matthew Moberg take us inside this dynamic sector with all its complexities and opportunities.

07.23.2019

US Tech Stocks: Seeing Beyond the Obvious

JONATHAN CURTIS
Vice President, Portfolio Manager, Research Analyst
Co-Manager, Franklin Technology Fund
Franklin Advisers, Inc.
San Mateo, California

MATTHEW J. MOBERG, CPA
Vice President, Portfolio Manager, Research Analyst
Lead Manager, Franklin Dynatech Fund
Franklin Advisers, Inc.
San Mateo, California

An investment in knowledge pays the best interest.”

Benjamin Franklin was right, particularly when it comes to investing in the whirlwind world of US technology stocks. That’s why we have asked Jonathan Curtis and Matthew Moberg to join this RoundTable. With nearly three decades of combined, specialized experience, they share their insights on a sector known for soaring stocks and sad stories. See their views on today’s headwinds and real growth opportunities.

Q: What’s your sense of the current landscape for US technology stocks?

Matthew Moberg: In our view, we’re living through the Fourth Industrial Revolution. In the late 1800s, major innovations such as the telephone, electricity and the combustible engine all sparked new industries, as well as major economic and social change. Right now, we see dramatic disruption underway in the industrial, retail, transportation, technology and financial services spaces. We have never been more optimistic about our ability to build a diversified growth portfolio focused exclusively on innovation. US technology stocks are a significant part of the story.

Jonathan Curtis: Digital transformation is a major theme for our portfolio, which features high-quality, sustainable growth stocks from the US technology sector. We believe every industry must go on a digital journey, building and applying data capabilities to better engage with customers and improve business processes through software. Digital transformation includes important and enduring subthemes such as artificial intelligence, machine learning, Internet of Things, cloud computing and digital payments.

Looking at the enterprise side, last year was an exceptional year for corporate technology spending. We think 2019 will remain a very good year for tech investment, mostly on the enterprise side and focused on the digital transformation theme.

Q: This sector faces several high-profile headwinds such as US/China trade tensions. How is this issue affecting your portfolio?

Matthew Moberg: US/China trade is just one of the portfolio risks we’re currently seeing. The only area we feel might be affected is the semiconductor and semiconductor capital equipment space. We think trade tensions are creating some permanent or semi-permanent movement by companies. In other words, it really doesn’t matter if tariffs disappear tomorrow; companies are developing strategies to move semiconductor manufacturing outside of China. Tensions are causing some volatility and we’re managing our exposure prudently. However, the current US/China situation isn’t driving our decision making.

Jonathan Curtis: It’s valuable to distinguish between the headlines and the reality of how things are unfolding. US export controls on semiconductors aren’t destroying end-market demand for such products. Even if China were to be completely cut off from buying US-made semiconductors, other companies would pick up the slack, buying US semiconductors to fulfil global demand for smartphones, PCs, 5G infrastructure and other electronic hardware.

Our framework is that ultimately all this gets solved, with China and the United States reaching some sort of settlement. We expect China, already a largely self-sufficient tech country, will work aggressively to build its own semiconductor industry. However, we believe that step will take years and, in the meantime, China will continue to rely on US-based semiconductor capital equipment companies.

Q: What are your thoughts on current valuations?

Matthew Moberg: There are pockets where things have become overvalued, but we continue to be able to build a good portfolio with stocks that we believe are undervalued.

Jonathan Curtis: Valuations have definitely moved up a bit over the past six months, but we still don’t think it’s anything excessive, given the structural growth opportunities in the sector and the high-quality business models we’re finding.

People have long memories about the financial crisis as well as the Tech Bubble and sky-high valuations of that period. As such, it’s understandable that investors get nervous when there’s volatility sparked by news on a range of issues. Given our understanding of the digital transformation theme’s magnitude, we take advantage of volatility to build on our holdings in companies best positioned to perform over the long run. During the late 2018 market swoon, we added to a handful of names that performed very strongly for us in the first quarter of 2019.

Q: Where are you finding opportunities?

Matthew Moberg: We have a large position in Amazon.com, Inc. Most investors rightfully associate the company with its e-commerce Marketplace and Prime services. However, we believe another piece of the business—cloud computing—is misunderstood and wrongly undervalued, mainly because the scale of market opportunity is much larger than investors appreciate.

Amazon also turned on advertisements 18 months ago. We think it will eventually compete with Google as an advertising platform. We have a solid grasp on how fast and how large advertising can grow. Take Facebook as an example. In 2012, their mobile-only revenue went from zero to $1.7 billion in two years and three months. In that relatively short period, Facebook achieved a quarterly run rate larger than CBS, probably the most successful broadcasting company in the United States. That rate of change, plus the high profitability of advertising at that scale, makes us optimistic about what’s in store for Amazon’s advertising venture.

We’re also positive about e-payments, specifically MasterCard Incorporated and Visa Inc. and own both stocks. There has been a lot of attempted competition by major firms aimed at these two businesses, all of which has failed or resulted in partnerships. Looking at US adoption rates, there’s still a ways to go. Looking at Western Europe, there’s an even longer runway of growth. Both firms already have growth rates ranging between 10.0% and 14.0% and are extremely profitable.

Jonathan Curtis: A top position in our portfolio is Salesforce.com, Inc., one of the largest and oldest companies rooted in software as a service model. The firm helps businesses understand their customers in a deep way and that’s essential to digital transformation. Workday, Inc. is well-positioned to help companies move to a software as a service model for better managing their human and financial capital. ServiceNow, Inc., which focuses on digitizing workflows, is already very profitable, and will likely become even more so in the years ahead. Twilio Inc. helps businesses engage with customers through all major digital channels, including the ubiquitous SMS channel.

While each of these companies is involved in the digital transformation theme, none are as well-known as Facebook, Amazon or Google. Being too narrowly focused on big names means missing out on hundreds of public companies and thousands of private companies. Our approach is oriented towards finding those technology companies that are lesser-known and still very early in their growth trajectory.

When we own a larger company such as Google, it’s usually the result of digging deeper to clearly understand the often less-obvious opportunity it presents. At first glance, Google is an advertising story and a business that’s facing regulatory risks around collecting and using consumer data. Inside Google, there’s an exciting and fledgling cloud computing company. Getting to the crux of that opportunity and others requires leading-edge research, on-the-ground knowledge and active management.

Q: What should investors be mindful of when looking at US technology stocks

Matthew Moberg: We believe deeply in the need for active management for two reasons. First, it takes in-depth capabilities to be on the right side of all the fundamental work necessary to take advantage of trends and changes. Second, investors need to be able to avoid some things that are popular in the press, but which don’t make great investments. For instance, we’ve never owned 3D printing companies, and while we think blockchain is revolutionary technology, we don’t believe it’s investable right now.

Amid this Fourth Industrial Revolution, it’s our job to examine all sides of ever-emerging opportunities. It’s the difference between investing and speculating. It’s where positive performance begins.

It’s valuable to distinguish between the headlines and the reality of how things are unfolding.” Jonathan Curtis

 

 

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