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Four ways to drill down into tech investing

  • Many of today's technology companies feature robust earnings growth, strong balance sheets and growing dividends.
  • The investor's task is not identifying the next revolutionary product but identifying long-term growth trends in each tech industry.
  • Four tech sub-sectors investors should keep an eye on are data analytics, cloud computing, cybersecurity and semiconductors.
Many tech companies enjoy robust earnings growth, strong balance sheets and growing dividends.
eclipse_images | Getty Images
Many tech companies enjoy robust earnings growth, strong balance sheets and growing dividends.

What we call the technology sector is really an aggregate of many smaller subsectors. For investors, it's key to look at these subsectors, which may offer unique long-term investment opportunities.

When was the last time you had an investment conversation in which no one mentioned one of the so-called FAANGs? Or FAAAMs? That's the stocks quintet of Facebook, Apple, Amazon, Netflix and Alphabet's Google that has come to represent the entire tech sector — and the answer is, probably, a very long time.

The growth prospects of technology are easy to imagine. What's more challenging is how to invest thoughtfully across the sector. Innovation is happening at breakneck speed, yet the run-up in top tech names has led investors to wonder about two things: First, is it too expensive? And second, where's my entry point?

Valuations are elevated, and for good reason: While it's true that tech tends to trade at a premium, we are far from a dot-com bubble repeat, in our view. Many of today's tech companies feature robust earnings growth, strong balance sheets and growing dividends.

What's more, tech is currently one of the few sectors with a strong secular growth profile. Innovation doesn't ebb and flow with market technicals — it is a structural, disruptive force, permanently separating winners from losers. In that light, it is rational for markets to place a premium on the sector. Valuations may be beside the point, particularly if tech earnings can continue to grow into their valuations.

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Follow the innovation

The array of innovation across tech and its "winner take all" tendency warrants a close examination of trends across different industries. This breakdown enables a deeper inspection of each trend's fundamental drivers, risk/reward profile and synergies with other trends. The investor's task, then, is not identifying the next revolutionary product company-by-company but simply identifying the long-term growth trend in each tech industry.

Four tech subsectors to power a portfolio

The good news is that it does not take a supercomputer to differentiate industries and uncover potential opportunities for clients. I believe software and semiconductors are two areas worth examining. Each industry brings its own risk/reward profile and captures different long-term growth trends, yet there is a strong feedback loop reinforcing each area's growth. We see several trends worth monitoring:

  • Data analytics: The growth of "big data" is bringing big opportunities. Major advances in machine-learning algorithms, faster hardware and cheaper computing power are helping companies leverage unparalleled amounts of data. These companies are using analytics to automate operations, understand customer behavior and monetize data. Data analytics adoption is in its infancy, yet sectors such as pharmaceuticals are already analyzing patient data at scale, finding biomarkers and generating breakthrough drugs at lower costs and faster speeds.

  • Cloud computing: The "cloud" is a broad concept covering software as a service (SaaS), platform as a service (PaaS) and infrastructure as a service (IaaS). While SaaS is already being adopted by companies, PaaS and IaaS are still underpenetrated markets presenting nascent growth opportunities. The economics driving cloud migration are powerful and sustainable. Companies can access secure, scalable computing power on demand, and at lower costs than traditional IT systems. This is the power and scale needed to integrate sophisticated data analytics into business processes.

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  • Cybersecurity: Brand and customer trust are critical to all companies, yet recurring headlines describing the latest hacks are constant reminders of the reputational and financial risks facing these companies. As companies increasingly rely on data analytics to power their business strategy — and as the cost and sophistication required to commit cyberattacks continue to fall — they'll need to increase security budgets to safeguard their data.

    Despite cloud migration, which has its own security measures, many companies still believe in a second layer of onsite cyber security measures. As cloud migration continues, cybersecurity may find a second source of demand.

  • Semiconductors: The future of the tech industry rests largely with semiconductors, its backbone. Every year, more chips are required to power an increasing number of devices, while end-user markets have broadened to include autos, communications and Internet of things applications. Industry consolidation has led to better supply discipline just as the demand base expands, which we believe may help dampen cyclical booms and busts yet preserve potential long-term growth opportunities.

    Growing demand for A.I. and data analytics across all sectors may provide another boost for semiconductors as data analytics, collection and storage drive demand for chips and semiconductor memory technologies. The strong demand is already appearing in the data. The August Semiconductor Equipment and Materials International report showed semiconductor orders increased to a 16-year high.

Returning to the two concerns at the start, valuations are indeed elevated — but for good reason. Investors waiting for a more attractive entry point might risk prioritizing market timing ahead of owning potentially strong, durable growth trends. In my view, financial advisors can uncover long-term growth opportunities and enrich client conversations by monitoring dominate tech themes.

— By Tushar Yadava, investment strategist at BlackRock

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