Key Takeaways

  • COVID-19 heightened the need for ‘innovation’
  • Companies are spending on tech ‘bells & whistles’
  • Don’t believe tech earnings will ‘run out of steam’

Today is National App Day! The app industry launched just over 12 years ago, when smart phone owners had a mere 500 options to choose from. Today, the Apple App Store and the Google Play Store have 1.96 million and 2.87 million available apps respectively, and nearly 70% of all US digital media time is derived from mobile app usage. With apps designed for entertainment, travel, business, fitness, productivity, and more, the slogan ‘there’s an app for that’ sure seems to be true. But just as our daily lives are engrained in technology, the equity market’s performance has been reliant upon technology too. In fact, the Info Tech sector is responsible for ~50% of the S&P 500’s year-to-date price return (S&P 500: 13.5% versus 6.8% S&P 500 ex-Info Tech) and it has outpaced all other sectors by at least 8.0%. Naturally, this level of outperformance causes investors to question if this strength can continue, so we have outlined our rationale to support our continued bias towards the sector.

    • Catalysts Not Running Out Of Steam | The expression ‘ necessity is the mother of invention’ has shown its truth this year, with the nature of the pandemic deepening our dependency on technology as many of us work from home and as infinitely more of us seek to stay connected with friends and family. But the COVID-19 outbreak also sparked changes in the way companies conduct business, forcing many to establish an online presence or to reconfigure operations in an effort to meet safety guidelines. From touchless payment options in retailers to telehealth appointments, technological advancements were needed in nearly every industry. Even after the pandemic has passed, the efficacies revealed by these shifts are likely to make these changes permanent. The rollout of 5G and ongoing innovations related to artificial intelligence should only accelerate these trends, and we expect industries not typically associated with tech to modernize their business practices as well (e.g., the use of drones in agriculture).
    • Companies Investing In All The Bells & Whistles | A sharp decline in business fixed investment was anticipated as companies were faced with shifting supply chains in the midst of lockdowns and an unclear outlook surrounding future demand. However, while overall business fixed investment is down 15% year-over-year, tech-related capital expenditures are up ~6%. In fact, the percentage of companies planning an increase in tech spending is at the highest level since January and is in the 90th percentile over the last 20 years. This trend began prior to the pandemic, as tech-related investment as a percentage of total business capital expenditures (capex) has increased ~25% (from 35% to 55%) since 2000. This tech-focus in business development further supports our expectation that innovation and automation will continue to gain traction across most industries.
    • Downloading The Details Of Valuations | Valuations for the broader market remain elevated from a historical perspective. Therefore, given that the Info Tech sector has a P/E multiple greater than that of the S&P 500 (29.7x versus 26.1x LTM), investors are concerned that the sector may be overvalued. Analyzing the metrics on a relative basis alleviates some of this concern, as historical data confirms that the sector’s multiple is typically higher than that of the broader index. It is also insightful to compare the sector to the ‘ reopening’ sectors and industries, as the latter have outperformed the tech-oriented names since the vaccine news was announced in early November. For example, the apparel and restaurant industries have valuations 1.7x and 1.3x that of the tech sector, respectively, and the airline, hotel, restaurant, and cruise industries lack earnings visibility until 2022.
    • Blazing The Trail Each Earnings Season | Consistent, positive earnings growth has remained a supportive factor for the Info Tech sector throughout this unprecedented year. It was widely accepted that the 2Q20 earnings season would be one of the worst on record due to the lockdowns, and the Tech sector was one of only three sectors to post positive year-over-year earnings growth ( 4.5%). The sector’s strength carried into the 3Q20 earnings season, as it had the second highest year-over-year earnings growth ( 7.6%) and the second highest percentage of companies exceeding estimates (92.6% versus 84.7% previous 20-quarter average). As we look ahead to 2021, Info Tech is expected to see double digit earnings growth in every quarter. The aforementioned long-term growth catalysts give us confidence that these expectations will be met, if not exceeded.