Secular growth is the hallmark of technology investing. Unlike commodities, which are cyclical in nature, the trends of technology are longer-term and reflective of fundamental economic and societal change. Think the Internet, smartphones and cloud computing.
Technology equities offer plenty of promise. But the sector is prone to hype, with unsophisticated investors buying companies with high valuations and little to no revenue. Today's hot gadget could become tomorrow's fossil. To help sort the electronic wheat from the chaff, three industry observers offer their picks.
Patrick McKeough, chief investment officer, Successful Investor Wealth Management Inc.
- The pick: CGI Group Inc.
- Price at last close: $60.93
- Price to earnings valuation (P/E): 19.1
A Canadian information-technology outsourcing and consulting firm, CGI Group is riding the trend of businesses handing over IT services to specialized firms. The company's price-to-earnings metric – how much investors are willing to pay for $1 of earnings – is low for the sector. Though this could be construed as investors souring on its prospects, the low multiple is more a reflection of the market overlooking CGI's steady earnings in favour of firms surrounded by hype based on their potential for profit. Moreover CGI plans to double its size in the next few years, in part through acquisitions, says Mr. McKeough. "Growing by acquisition can add risk, but the company's balance sheet is strong," he says.
- The pick: International Business Machines Corp.
- Price at last close: $152.77 (U.S.)
- P/E: 11.5
Analysts have long predicted the old man of the tech sector will soon go gently into the good night of obsolescence – hence its low earnings multiple. But don't count out one of the world's largest tech companies yet, Mr. McKeough says. IBM has been redirecting its business from mainframe computers and consulting into developing analytics software and cloud computing. Revenue from these arms increased 17 per cent in the first quarter, and now they account for 37 per cent of all revenue. The question is whether the company can continue to grow these offshoots to offset the diminishing growth in its core business.
Mark Lin, portfolio manager, CIBC Global Technology Fund
- The pick: Fiserv Inc.
- Price at last close: $105.13 (U.S.)
- P/E: 29.7
A big player in the growing "fintech," or financial technology, industry, this U.S.-based company benefits from banks and insurance firms outsourcing back-office functions, such as ATM and website maintenance, compliance functions and cheque processing. Mr. Lin says its valuation is lower than "the sexy names" of the tech sector, which have much higher earnings multiples. Yet its business is growing at more than 12 per cent, and its services are "sticky," which means once "you outsource back office, as long as the service provider does a good job, it's hard to pull out." But the industry is competitive, so if Fiserv fails to continue gaining clients at a faster pace, its share price could suffer as investors look elsewhere.
- The pick: MasterCard Inc.
- Price at last close: $97.13 (U.S.)
- P/E: 29.3
MasterCard is not what most investors would classify as a tech company, but Mr. Lin says the credit-card firm has positioned itself as a major player in a cashless world. "It's a leader in the secular trend where electronic money is replacing the use of cash everywhere." In particular, its growth is related to micropayments. "Ten years ago, if you tried to pay for a coffee at Tim Hortons [with a card], it was a strange thing, but today, it's very convenient. You don't need to carry cash." Its main competitor is obviously Visa, but Mr. Lin says his CIBC fund holds a larger position in MasterCard because of its potential for faster growth. Correspondingly, the risk for investors is if the company cannot continue to grow as quickly as anticipated, particularly into emerging markets.
Colin Fisher, portfolio manager and president, Stableview Asset Management Inc.
- The pick: Tecsys Inc.
- Price at last close: $9.79
- P/E: 93.5
A Montreal firm providing logistics and supply-chain IT services, Tecsys has big-name clients, including the world's largest buyer of alcoholic beverages, the Liquor Control Board of Ontario. Tecsys has been "winning huge business in the health-care space," one of the fastest growing sectors in the U.S., Mr. Fisher says. "They've been doing that time after time, going up against big competitors." While the company has a high P/E, the figure can be misleading because growing firms often reinvest free cash back into the company, which affects earnings. A better measure of potential is the enterprise multiple for next year of about 11.5, which is "reasonable for its type of business," reflecting that about half of its revenue is recurring. "Many companies like this can go into multiples of 15 to 16 without much of a sweat."
- The pick: VersaPay Corp.
- Price at last close: $1.05
- P/E: Negative
This Toronto-based financial tech company has two arms, payment processing and automated accounts receivable. It's the latter that holds the most promise, Mr. Fisher says. "The company has been around for a while, but its ARC [accounts receivable] implementation has only started to gestate in the last year and a half." Over that time, it has gained 42 new clients with about 17,500 payers. "This new business is just about outstretching the old business," he says, adding that its ARC business grew 76 per cent in the past year. "It went from zero per cent of its total business to about 20 per cent in one year." While the firm shows negative growth year over year for earnings, that's largely a result of it reinvesting in its ARC enterprise. Its risk is execution while competing against larger companies in the U.S.