Beyond the FAANGs: Technology Stocks and Downside Protection

Technology stocks are widely seen as powerful return drivers—with a lot of volatility attached. But surprisingly, shares of many companies that enable the technology revolution can provide solid returns and even downside protection.

It’s been a volatile year for technology and new-media stocks amid controversy at Facebook and concerns about Amazon’s dominance. While the so-called FAANG stocks (Facebook, Amazon, Apple, Netflix and Google*) have delivered big gains in recent years, the associated risks have fueled anxiety about the entire sector.

Technology Enablers Have Resilient Businesses

Blanket fears about technology are off the mark, in our view. In fact, the sector includes many companies with solid business models, driven by long-term technological trends that don’t face the same risks as the mega-caps do. It might sound counterintuitive. But we believe technology stocks with the right attributes can actually help protect a portfolio against spikes of market volatility.

These companies are not household names like Facebook and Google. But many supply the sophisticated plumbing that enables the internet-driven magic of modern life, which supports recurring revenue streams as technology spreads globally. They operate behind the scenes and may not have consumer-facing brands. As a result, these companies aren’t in the crosshairs of politicians or regulators and are unlikely to be hurt by imposed changes to the industry structure.

What kind of technology companies fit the defensive bill? Think about companies that create enterprise software for banks that enable online transactions or process credit card purchases. Other examples include internet companies that help you make travel plans or keep track of your cell phone usage.

Looking beyond the FAANGs is a starting point to understand how some technology stocks can be defensive. The next step is to assess the sector for companies that offer quality and stability, and trade at attractive prices, which we believe are the three key components of downside protection.

Quality: High Profitability and Cash Positions

Many technology groups—especially in software—operate with low asset intensity and high profit margins. First movers with new technologies can secure a big advantage in niche businesses, which drive predictable, long-term profit streams. This helps foster strong cash positions—a vital ingredient for downside protection, especially in a rising-interest-rate environment.