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Is there any value in tech?

We explore some potential value plays within the tech sector and how to find them.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

The sell-off in the tech sector this year has been accompanied by the idea that tech stocks are overvalued. With interest rates on the rise, this assumption can’t be completely discounted. In general, tech investors are typically willing to pay more for each pound’s worth of expected earnings.

However, rising interest rates make future profits worth less in today’s money. So all things being equal, in a low-rate environment £100 of profit in ten years might be worth £5 today. But in a higher-rate environment, you might only be willing to pay £3 for that same £100.

But that doesn’t mean all tech stocks are overvalued. In fact, there are some that are arguably undervalued.

To understand why, and get a better idea of how to find these diamonds in the rough, it’s important to understand how to value tech stocks.

This article is not personal advice, if you’re unsure whether an investment is right for you, seek advice. All investments and any income they produce can fall as well as rise in value so you could make a loss.

How to value tech stocks

The most common way to value a share is the price to earnings (PE) ratio. It tells you how much investors are willing to pay for every pound of profit a company delivers. Generally, the higher the number the more valuable the market thinks the company is. It’s best to compare PE ratios between similar companies within the same industry.

For growth stocks, there’s a bit more to it though. When a company expects to grow its earnings quickly over time, that’s not necessarily reflected in the PE ratio. That’s where a PEG (Price/Earnings/Growth) ratio comes in. To calculate it, divide the PE ratio by the company’s estimated annual growth rate.

In general, a PEG ratio under 1 is considered attractive. This is an important metric for tech stocks because they tend to sit in high-growth industries.

Not all tech stocks sit firmly in the growth category though. Some also offer income by way of dividends. These stocks could have a lower growth rate because they’re paying out part of their profits to shareholders.

For these stocks, a PEGY ratio is more appropriate. It takes dividend payments into account and is a useful way to compare the tech stock valuations when there’s a dividend involved.

PEGY= PE ratio/(% earnings per share (EPS) growth+ % dividend yield)

Remember ratios and figures shouldn’t be looked at in isolation, it’s important to consider the bigger picture.

Our share research team do much of this legwork for you on a large selection of the most popular stocks. To get updates and insight sent straight to your inbox, sign up for our Share Insight email.

Investing in individual companies isn’t right for everyone – it’s higher risk as your investment is dependent on the fate of that company. If a company fails, you risk losing your whole investment. You should make sure you understand the companies you’re investing in, their specific risks, and make sure any shares you own are held as part of a diversified portfolio.

Semi stocks scrape the bottom of the barrel

Semiconductor stocks are some of the most beaten down in the tech sector. Everything from calculators to washing machines use the tiny chips, though they’re best known for their role powering smartphones and computers.

As a group, they’ve tended to deliver market-beating growth over the past few years and investors paid a pretty penny for it. But with many looking for ‘safer’ picks in the current inflationary environment, they’ve been abandoned.

Semiconductor vs. US Tech Performance

Past performance isn’t a guide to future returns. Source: Refinitiv, 22/02/2022.

There’s reason to be cautious. Semiconductors tend to be in high demand when the economy is booming, so worries that consumers will be tightening the purse strings could weigh on growth.

Developing new, state of the art chips is an expensive undertaking and requires a great deal of investment. Once a new chip is released, the company needs to sell a lot of them to make up for the outlay. Input costs are also a concern. As the manufacturing materials and labour become more expensive, semiconductor companies will have to choose between giving up part of their profits and passing that cost on to customers. The latter could mean fewer chips are sold.

But there’s an element of throwing the baby out with the bath water if you discount the sector completely. Lots of those headwinds are likely to be short term. The industry supports some of the strongest long-term trends in tech. The chips are required to power cloud computing, electric vehicles, and artificial intelligence – all of which should continue to offer growth for some time to come.

Qualcomm’s value tilt

Qualcomm, a wireless specialist, fits into this category of lowly valued semiconductor stocks. The group’s business model makes it a unique choice within the industry. Qualcomm is making money on just about every smartphone sold. That’s because it holds the patents for most of the 3G, 4G and 5G wireless connectivity.

So even if another company manufactures the chip, Qualcomm gets to skim a bit off the top. This part of the business accounts for roughly 20% of overall revenue. The rest comes from Qualcomm CDMA Technologies (QCT), which makes and sells the chips themselves.

The business is heavily weighted toward smartphone sales, no bad thing considering they’re glued to just about everyone’s hands these days. However, phone makers are starting to make their own components to gain a tighter hold on their supply chains. This hasn’t materialised as a full-blown headwind just yet – in the first quarter, the group saw smartphone chip sales rise 42%.

Still, it’s important the group’s other end markets like Automotive and Internet of Things continue to offer other ways of making money.

QCT Q1 Revenue (billions USD)

Source: Qualcomm 2021 first quarter results.

The group’s enjoying the benefits of scale with operating margins expected to settle between 36-38% over the next three years. That’s translated into free cash flow of more than $8.5bn, a nice safety net to help see the group through any near-term volatility.

That adequately covers the group’s 1.6% dividend yield. It also helps support the case for any additional shareholder returns in the future, though remember that yields are not a reliable indicator of future income and nothing is guaranteed.

The valuation isn’t too demanding either – shares change hands for roughly 14 times forecast earnings. Accounting for the group’s growth rate and dividend yield with the PEGY ratio, shares have an even more attractive valuation well below 1. This reflects uncertainty ahead - the group’s reliance on handsets coupled with industry-wide supply chain concerns shouldn’t be overlooked.

Find out more about Qualcomm shares

Any value in the FAANGs?

Facebook parent Meta, Apple, Amazon, Netflix and Google parent Alphabet have become synonymous with growth stocks. The five have grown so large, they now make up 17% of the S&P 500’s total value.

Market capitalisation

Source: Refinitiv, 17/02/2022.

They’ve also been some of the hardest hit by the recent tech sell off. This is to be expected. As we explained above, the hefty profits investors are expecting from this group down the line are now worth less in today’s money than they were last year when rates were low. However, we think there could be some value left within the group.

Meta is the obvious candidate as a value member of the FAANGs. The group’s been blasted after a lacklustre fourth quarter results. The main concern was management’s expectations for sluggish advertising revenue, the group’s bread and butter.

As a result, Meta’s now trading near its lowest ever valuation, which it reached at the height of the pandemic sell-off. Its PEG of 0.41 is another indicator that it could be under-priced.

Meta’s family of apps has more users than any other platform. That’s a lot of customer data that can be leveraged for targeted marketing. Consistent per-user revenue growth shows it’s an avenue that advertisers aren’t willing to ignore.

AI and virtual reality could also increase user engagement down the line, so the sluggish growth could be a blip on the radar in the longer-term. Add to that an impressive $48bn net cash position and no debt to speak of, and you have a pretty strong cushion for any potential bumps ahead.

Bumps could be somewhat of an understatement, though, if the group’s unable to bolster ad revenue in the medium-term. We’re yet to see a convincing plan for adequately monetizing parts of the business, like WhatsApp. And metaverse ambitions still feel a bit pie-in-the-sky. Investors should be prepared for some trying times in the short term.

FIND OUT MORE ABOUT META SHARES

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A connected party of the author holds shares in Apple.

Unless otherwise stated, estimates are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

What do value fund managers think of tech?

Josef Licsauer, Investment Analyst

Funds are a good way to invest in a range of companies within a single investment, run by professional managers. They also invest in a variety of sectors, not only technology. This offers more diversification and helps smooth out some of the ups and downs that come with investing in individual companies.

We asked investment experts that use a more value-focused investment approach about their views on technology and some of the potential value technology options. Please note that Hargreaves Lansdown may not share the same views. Any yields mentioned are in relation to some of the funds underlying holdings and are not a reliable indicator of future income. This is not a recommendation to buy, sell or hold any of the mentioned underlying holdings.

Investing in funds isn't right for everyone. Investors should only invest if the fund's objectives are aligned with their own, and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.

Jupiter Fund Management – Jason Pidcock, manager of Jupiter Asian Income

“My largest 3 technology positions, relative to my benchmark, are in Taiwan: Hon Hai and Mediatek and in South Korea: Samsung Electronics.

I hold Hon Hai because it is a true global leader – the largest contract manufacturer in the world, with numerous customers – the biggest of which is Apple. It has a global footprint, enjoys economies of scale, is large and liquid, the shares are on a low PE of about 10x 2022 earnings and offer a very attractive dividend yield of about 5% gross. The balance sheet is in a net cash position. Hon Hai is a Taiwanese company but is one of the largest manufacturers in China, and is one of China's largest exporters.

MediaTek designs advanced computer chips. Its core businesses include Mobile, Home and Automotive. I am happy to invest in Mediatek because it is a global leader, is great value – on a 2022 PE of 13.5x, with a gross yield close to 7% and a net cash position on the balance sheet. The shares have performed very well in recent years but still appear very attractive.

Samsung is one of the largest electronics companies in the world, and one of the best known (particularly for semiconductors and handsets), but the shares still offer a lot of value, trading on a 2022 PE of about 10x earnings and yielding over 2%, but with scope to significantly increase the dividend, due to a large net cash position on the balance sheet.”

Read our latest update on the fund

Man GLG Group – Jeff Atherton, lead manager of Man GLG Japan CoreAlpha

“As contrarian, value investors we naturally look to recovery and turnaround situations within established businesses, rather than new entrants and new products/markets.

A few years ago we had big positions in the likes of Sony, Nintendo, Canon, Ricoh and Fujifilm. Right now our exposure is smaller, but we do have Panasonic, Mitsubishi Electric and Kyocera. With technology companies we have found that the risk of obsolescence is higher than in other industries, and the key is to invest in larger companies with a strong brand, or significant market position, which is based on R&D strength and a long accumulation of know-how and customer relationships. A strong balance sheet is also essential.

The danger is of course that the structural decline is accompanied by an inability to re-invent, and the shares will be a very poor investment. In Japan companies such as Pioneer have faced this situation over recent decades. There is no substitute to detailed research to try to separate the good from the bad, but the rewards can be impressive. Sony today has a market value of around U$140bn. At the end of 2012, when investors were convinced it would lose out to Apple and Samsung, it was worth less than U$10bn.“

Read our latest update on the fund

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    Our fund research is for investors who understand the risks of investing and that investing in funds isn't right for everyone. Investors should only invest if the fund's objectives are aligned with their own, and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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