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Titans of Tech
Toronto: December 02, 2013
By John Stephenson

Markets are running hard with the S&P 500 and Dow hitting all-time highs.  Also, breaking a ceiling of sorts is the Nasdaq, which finally cracked through the 4,000 level for the first time in 13 years, this past week.  Despite achieving this latest milestone the Nasdaq is still 20% below its dot.com-fueled highs, with the information technology (IT) sector lagging behind the broader S&P 500.  But a closer inspection of the data suggests that it is not so much that technology is out of favor, but rather it is a rotation within the technology sector toward new upstart companies and away from the established players.  Small cap tech names have been on fire while the large cap tech stalwarts have been lagging the market on a year-to-date basis. 

Many of the most vaunted names in tech are trading at discounted multiples to the broader market because they are seen as producing products that are commoditized.  PC manufacturers, microchip makers and mainframe providers are out of favor while anything to do with social media, the cloud or mobile are the new “it” companies.  IBM is case in point.  Last month the tech giant approved a $15 billion increase in its share repurchase program, which caused the shares to spike 2.7 percent on the day of the announcement.  But the announcement followed closely on the heels of the company posting a decline in sales for the sixth straight quarter. Despite IBM’s efforts to return cash to shareholders to bolster the share price, the stock is down six percent on the year.

Microsoft has struggled to find its place in this new world of tech.  It’s been hard at work revamping its operating system over the years and trying to convince users that a new look or way of doing things is worth the trouble.  Take its troubled revamp of Windows 8.  The revamp of Microsoft’s operating system featured not only a new look, but the operating systems was pressed uncomfortably into a dual role—it is now the operating system for both desktops and tablets.  Anguish greeted the debut of this operating system with users dismayed by the absence of the trusty Start button and confusion reigned supreme over its application to mobile devices.  This despite the fact that Windows 8 is generally now considered a good operating system that builds on the strengths of Windows 7, is easy to install and boot and comes with anti-malware software baked in.  All of this fussing around over the operating system, the heart and soul of Microsoft, was to try and position the company for the future.

In October of this year, departing chief executive Steve Ballmer said “Our devices and services transformation is progressing and we are launching a wide range of compelling products and experiences this fall for both businesses and consumers.”  By that he means the Surface tablets, the Xbox One and the Nokia devices that are about to be swallowed up by Microsoft.  But with Surface tablet sales swirling the drain, and organic development of compelling hardware stalling, is Microsoft likely to see the explosive growth that marked the Bill Gates era?  No.

Where the smart money is heading today in tech is toward the SMAC stack, those companies that are offering promise in social media (S), mobile (M), analytics (A) and the cloud (C).  While the SMAC stack currently accounts for 20% of IT spending, it is projected to account for 80% of all IT spending by 2020. 

Driving these broad new trends in technology is a sea change in the way consumers and businesses go about their day-to-day lives.  By 2020, Ericsson expects there to be 50 billion connected devices globally that will power the continued rise in social media.  This year alone, nearly 1.2 billion smartphones and tablets will ship, a rise of 37% year-over-year and a number four times greater than the number of personal computers that will ship.  This coupled with a rise in the bring-your-own device to work phenomenon will help sustain the rapid growth of mobile applications and computing.

Driving the growth in analytics is an explosion in data.  Some have estimated that the amount of data created will rise by 50 times over the next ten years to 40 zettabytes by 2020.  The other area of growth is the cloud, with cloud spending expected to reach $60 billion annually a year-over-year increase of 26%.

For my money, tech remains one of the most attractive sectors in the market today.  When I screen tech against the other sectors in the market it has the highest growth rates, the most cash and the best balance sheets of any sector. The key for successful investing in tech is the same as in other sectors—differentiate between what’s hot and what’s not.

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