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Is there growth in tech for 2022?

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Higher discount rates are making technology stocks fall

Technology has been the best performing sector for years but 2022 looks set to be different. With inflation and interest rates rising, investors are now wondering if technology’s run could be over.

To learn more, Gemma Weeks, Senior Business Development Manager from ETF Securities, spoke with Brian Colello, the Director of Technology Equity Research for Morningstar.

They started by talking about how technology companies have been hard hit this year thanks to rising inflation.

Brian explained this was because as inflation and interest rates rise, investors apply higher discount rates to companies’ future earnings. Companies with earnings in the very distant future can be especially hard hit. He said:

“If we look at growth companies in tech, where a lot of earnings will be generated in the future, particularly software, those earnings will be generated in the future. They're going to be discounted at a higher rate. That should lead to lower valuations.”

He added that work from home stocks were fully priced during the Covid lockdowns. Meaning a correction for these stocks was potentially inevitable when economies reopened. “Quite frankly, we thought a lot of these software stocks were overvalued a year ago, certainly, the high flying, remote working names, SAS names, things like that, so to some extent, some of this pullback was warranted regardless of interest rates, but that's what we're seeing,” he said.

Buy the dip on Salesforce, ServiceNow, Adobe

Gemma then asked if the tech selloff was one of those opportunities to “buy the dip” that has worked so well for tech investors the past several years.

He replied that he thought it was a good idea to buy the dip, but said investors should be selective about what they buy. Morningstar is most interested in high quality, wide-moat software companies. He cited Salesforce, ServiceNow, Adobe as his favourite stocks to buy in early-February 2022.

He added that the sell off had changed his mind on some of the fast-growing tech glamour stocks too.

“We did not like Zoom as a $550 stock, but we like it as $140 stock. We didn't like Palantir at $45, but we like it at $13. DocuSign's another name that's cheap versus a year ago and it has a unique business model. Twilio's another one of our preferred names,” he said.

“So, you know, the high growth names, some of them, I think we're seeing down 60, 70%, I think there's some opportunities there if you're willing to take on a little more risk.”

Gemma then asked him what the current market may mean for our own ETFS Morningstar Global Technology ETF (ASX Code: TECH), which uses Morningstar’s research and invests in many of the stocks he mentioned.

He said that it’s impossible to know how the fund would move in the short term. But by focussing on high quality software companies with sustainable competitive advantages, TECH was well positioned for the longer time horizons.

She finished her time with Brian talking about what the future may hold. Technology is always changing. One of the nicest things about it is that there is always something new and exciting going on. So she asked Brian what was exciting him most.

He said he was most excited about cloud computing, which is where companies rent out their servers and software to other people and companies. And thereby save people the time and cost of buying their own hardware and software systems – and further saves them the rigmarole of constantly having to buy new tech to stay up-to-date.

Skyworks solutions: a Morningstar favourite

He ended by saying that one of his favourite stocks currently was semiconductor business Skyworks Solutions. He said:

“Skyworks Solutions and that's a stock trading at about $145. We think it's worth $210. So another name that looks cheap to us. They are a leading supplier of radio-frequency chip content or RF. They're mostly used in smartphones, basically, to filter and amplify signals going from the cell phone to the towers and from the towers to the cell phone. So they're mostly a smartphone business, but they are increasingly being adopted in non-smartphone, so things like, I call them gateways and routers, cars, medical devices.”

Investing in technology

Investors wanting to invest in global technology companies can do so via the ETFS Morningstar Global Technology ETF (ASX Code: TECH). TECH invests in 25 to 50 global technology companies across areas such as software, semiconductors, data processing, computer equipment and databases. Companies are screened using Morningstar’s proprietary moat methodology, to include only those companies that are identified as possessing strong competitive advantages relative to their peers. Further, companies are selected for the index on the basis of how attractively they are priced relative to their fair value, as evaluated by Morningstar’s team of equity analysts.