by Patrick Commins
Investors in Aussie equities have long bemoaned the absence of opportunities in the technology sector. The decision by Atlassian in 2015 to skip the ASX and go straight to New York seemed to reinforce fears that we would never generate the type of listed tech sector a country with such a highly skilled and digital savvy workforce deserves.
But in the absence of the big blockbuster names, a quiet tech revolution had been gathering steam at the shallower end of the bourse.
The explosive share price performances of the likes of Wisetech, Appen, Altium, Afterpay and Xero have lifted hopes of a new vanguard of ASX-listed tech names to be added to well-established icons such as digital classified businesses REA Group, Carsales and Seek. These young Turks have even earned their own acronym: the WAAAX stocks.
Despite all the hullabaloo, tech as a sector comprises only 2.5 per cent of the ASX 200 index by market capitalisation. Tech's representation in America's S&P 500 index is 10 times that.
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But again, all the action is happening at the smaller end. Over the past five years tech's share of the S&P/ASX Small Ordinaries index has more than tripled, from 2.6 per cent to 10.5 per cent. Frustratingly, the numbers only go back to 2001, which means we can't compare today's presence with the height of the dotcom bubble, when the likes of Looksmart, eCorp and Sausage Software promised the world but ultimately delivered nothing but ashes.
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But while the valuations might look frothy today, the similarities with the turn of the millennium ends there.
"The main difference now versus the dotcom bubble is that the current group of tech stocks are in most cases genuine businesses," DNR Capital portfolio manager Sam Twidale says. "They have products with leading market positions, are generating real earnings and are backed by strong balance sheets." Global reach
And through tech, investors also get the opportunity to buy into businesses with global ambitions, says Twidale, who is running the newly-opened Australian Emerging Companies fund for the Brisbane-based fund manager.
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Indeed, the community of small cap managers is jumping on board. Analysis of Morningstar data on 70 funds shows an average exposure of close to 14 per cent to the tech sector. At the very top is Hyperion's Small Growth Companies fund, with almost half its money devoted to tech, while the likes of Colonial First State's Future Leaders fund and Allan Gray's Australian Equity fund have no exposure.
Professional investors agree that there is a strong, longer-term story around some of the high-profile wave of tech stocks. But new investors have to contend with the risk of getting burnt by getting in late on a trade that is running red hot around the world.
"The problem in Australia is that we have so few listed tech businesses that those with substance get bid up too far, just on supply versus demand," Bennelong Australia Equity Partners investment director Julian Beaumont says. "It's probably the one area of the market that's somewhat out of whack."
Twidale, who has a quarter of his fund in tech, agrees that discipline around valuations is crucial right now.
"These high-quality tech businesses can turn out to be poor investments if you overpay," he says.
For example, Wisetech has quickly become the largest software company in the small cap index trading on a P/E of above 100.
"Although the business model is impressive, the incredibly expensive valuation presents downside risks if the very high expectations can't be met," Twidale says. Lofty valuations
He prefers a company like Bravura Solutions, a rapidly-growing global software provider to the wealth management industry, which trades on a "significantly cheaper valuation".
His fund also holds data centre operator NextDC, Domain and MYOB, as well as less known names such as Pushpay, a payments processing company that targets church groups, and Megaport, which provides connectivity to cloud and network services providers and boasts proven tech entrepreneur Bevan Slattery as chairman.
For now, shareholders are likely to continue to jump at the chance to slake a desperate thirst for companies that offer the potential for earnings growth in a low-growth environment. And tech is very much part of that story.
Citi strategists say their universe of "growth stocks" as a group are trading on a forward P/E ratio of 28, up from 20 three years ago. That's despite the medium-term earnings growth outlook staying pretty steady at 12 per cent over that period.
Tech as a group is also trading on a P/E of 28, with annual profit growth estimated at 14 per cent over the coming three years, Citi says.
From these lofty valuations, the strategists believe the returns from growth stocks broadly over the coming few years "are likely to be limited", and they see "more potential in value names".
Indeed, "value" small cap funds are unlikely to have much in expensive tech names, the Morningstar data shows, with an average exposure of only 5 per cent (the aforementioned Allan Gray fund is classified as value and contrarian).
"Timing a change in performance and identifying the catalyst is inevitably difficult, but avoiding overvalued situations generally pays off in the end," the Citi strategists say.
MP1 Price at posting:
$3.81 Sentiment: Buy Disclosure: Held
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