The technology sector was a strong outperformer in the market at the beginning of the COVID-19 pandemic and performed similarly to the market in 2021. The technology market performed poorly in the first quarter of 2022, with many companies performing more worse than the general sector. However, the performance of the technology still exceeds the overall US market on a following 12-month basis. We still love the secular tailwinds associated with cloud computing, 5G, and the “Internet of Things.” So, we view the return of technology as healthy and will direct investors toward high -quality software companies that are wide moat, such as Salesforce.com (CRM)Service Today (NOW)and Adobe (ADBE)Among others.
On March 25, the Morningstar US Technology Sector Index rose 22% on a TTM basis, which is more than the performance in the US equity market, which rose 14%. In the past quarter, the technology has performed poorly in the broader market, down 10% compared to a 5% decline by the U.S. equity market.
Exhibit 1: The gap between tech and the broader market narrowed in Q1, however.
– Source: Morningstar
On March 25, the median U.S. technology stock was 6% undervalued, a sharp reversal from a sector that was overvalued by 6% and 14% one and two quarters ago, respectively. However, while the high number of undervalued mid- and small-cap stocks has lowered the median valuation, on a market-capitalization basis, overvalued large-cap stocks are bringing the tech sector to fair. value territory.
Software remains the most attractive subsector. High -flying growth stocks from 2020 have fallen, and many are now trading below our fair value estimates. Meanwhile, more mature, higher-quality software stocks have also been sold and are now giving investors an attractive margin of safety. Many semiconductor companies are also undervalued, while hardware is relatively undervalued.
Exhibit 2: We see buying opportunities in software and semiconductors.
– Source: Morningstar
In software, IT departments are focused on digital transformation, first from the secular shift to cloud computing and software as a service, followed by the coronavirus pandemic and the critical rush to implement remote working tools. We anticipate businesses using software to modernize all types of business processes, which in turn leads to the growth of the software industry at low-double-digit CAGR.
Exhibit 3: Cloud opportunity is the most obvious secular theme in software.
– Source: Morningstar
Additionally, we see an ongoing boom of data that is not only great for cloud computing, but also database management systems. Traditional databases such as Oracle’s (ORCL) there is still room, but emerging beneficiaries are companies with leading data-lake, data-warehouse, and data-marketplace offerings, such as Snowflake (NIYEBE) and MongoDB (MDB).
Exhibit 4: Data explosion, including DBMS revenue, should not slow down.
– Source: Morningstar
Top Picks
Salesforce.com (CRM)
Star level: ★★★★★
Economic Moat Rating: Broad
Estimated Fair Value: $ 320
Fair Value Uncertainty: Moderate
We believe Salesforce.com represents one of the best long-term growth stories in software largely due to its ever-expanding portfolio of complementary solutions that allow users to fully embrace their customers, in thus building relationships, strengthening retention, and driving revenue. In our view, Salesforce will benefit more from natural cross-selling in its clouds, upselling more robust features within product lines, pricing actions, international growth, and continued acquisitions, such as recent deals for Slack and Tableau.
Service Today (NOW)
Star level: ★★★★
Economic Moat Rating: Broad
Estimated Fair Value: $ 700
Fair Value Uncertainty: Moderate
ServiceNow excels at implementing a land-and-expand strategy, and it continues to leverage its workflow automation power to penetrate existing IT customers more deeply and more broadly into HR, customer-service- specific, and other back-office products. We expect that both the tier offer and vertical-specific version will continue to provide a good tailwind to revenue. We think ServiceNow has become a key partner in digital innovation, as shown in retention statistics, remaining at the elite level. We admire ServiceNow’s excellent balance between strong and visible revenue growth and stable and expanding margins.
ASML Holding (ASML)
Star level: ★★★★
Economic Moat Rating: Broad
Estimated Fair Value: $ 800
Fair Value Uncertainty: Moderate
ASML is one of our leading semiconductor picks thanks to the increasing use of intense ultraviolet lithography at large chipmakers such as TSMC and Intel to support explosive chip demand. Although the company’s outlook in the first quarter was negatively affected by supply chain barriers, we think ASML will outperform the wafer fab equipment industry by 2022 (20% revenue growth compared to 15% for WFE). With TSMC, Intel, and Samsung all vying for leadership in process technology, we expect ASML to be the main beneficiary as it sells tools to all three chipmakers.