A small but plucky group of Canadian IT names is quietly trouncing not only the overall stock market, but also the colossal U.S. tech sector.
The S&P/TSX Composite Technology Sector Index was the class of the Canadian stock market in 2019 with a 64-per-cent return, and the streak has continued into this year, with another 12-per-cent move in just the past three weeks. On Wednesday, Shopify Inc. hit an all-time high of $610.31 a share.
For a market dominated by resources and banks, tech leadership is a novel twist. The only problem is there are too few of them – just 10 domestic tech stocks are big enough to be included in the S&P/TSX Composite Index.
By comparison, the S&P 500 Technology Sector Index has 70 tech companies totalling US$6.8-trillion in market capitalization, and that doesn’t even include internet giants Facebook Inc. and Alphabet Inc. or e-commerce powerhouse Amazon.com Inc., which are typically classified in other sectors of the index.
“There’s a massive shortage of good, liquid tech companies in Canada,” said Peter Hodson, founder and head of research at independent firm 5i Research. Limited supply and rising investor demand for tech exposure have fuelled the recent rally, Mr. Hodson said.
“Combine that with portfolio managers who tend to want to overweight sectors that are doing well, and you get this upward and onward trend.”
In the United States, the tech sector has become so large and such a dominant force in the market, it’s inviting comparisons to the investor frenzy for dot-com stocks two decades ago.
But in Canada, the sector never really recovered after the tech bubble burst. The entire ecosystem for investing in tech stocks withered, as money managers, equity analysts and investors retreated from technology.
By 2009, the number of tech stocks in the benchmark index fell to as few as five. And the country’s history with tech sector flameouts, namely Nortel Networks Corp. and BlackBerry Ltd., still loom over the Canadian stock market.
But then came the rise of Shopify, and suddenly Canada has another bona fide tech champion with a global profile.
As Shopify’s e-commerce platform has come to power hundreds of thousands of internet merchant sites, the company’s stock has risen more than ninefold in just three years.
But there are other rising stars in the sector. Constellation Software Inc., Descartes Systems Group Inc., and Kinaxis Inc. have all posted returns of more than 50 per cent over the past 12 months. And Lightspeed POS Inc., the latest addition to the sector, has advanced by 175 per cent since going public last March.
For most of the Canadian tech space beyond Shopify, however, valuations are still considerably lower than in the U.S. market.
Many Canadian tech stocks are not liquid enough for institutional investors to build a position. The lack of institutional support serves to keep valuations relatively muted, Mr. Hodson said. “Two of our favourite names in the space are Constellation and Enghouse, but neither company has issued stock in more than a decade.”
Outside of the S&P/TSX Composite Index, the valuation gap among smaller tech names widens further, said David Barr, chief executive of Vancouver-based PenderFund Capital Management.
“For stuff that's a little bit more off the radar, the lack of a tech investor base in Canada really starts to impair valuations. That's where we're seeing companies trade at 50 cents on the dollar compared to U.S peers.”
Many Canadian startups are also finding ample sources of funding outside of public markets. With private equity and venture capital growing considerably in recent years, the flow of new tech companies into the stock market has slowed to a trickle.
But the runaway success of Shopify as a public company, as well as Lightspeed’s successful IPO, may persuade other entrepreneurs to consider listing on the stock market, Mr. Barr said. “I think entrepreneurs and private company backers are much more willing today to go into the Canadian public markets than they would have been five years ago.”
Shopify’s run is also helping spur investor demand for other Canadian tech listings, Mr. Hodson said.
“If you’re a portfolio manager that passed on Shopify at $100 [a share], you start looking at some of the other names pretty seriously.”