US IT: Leading innovative growth in the new economy
"Despite being in their early stages, ‘wearables’ could be a long-term growth driver for the IT sector, as the broader trend of ‘Internet of Things’ takes off.”
Chief Investment Office
UBS Wealth Management
The only thing constant in technology is change. Every year, new buzzwords such as mobility, cloud, big data, and social networking take center stage. As some investors latch on to new, emerging trends, it invariably brings an element of volatility and overvaluation to stock prices. While the sector today has its fair share of high-flying stocks that owe their valuations more to hype than fundamentals, they are far from representative of the technology universe. In fact, investors are more likely to uncover value in the S&P 500 Information Technology sector.
The S&P 500 IT index – by definition a pure-play exposure to the biggest names in the industry – is trading at a fraction of the 80 times price-to-earnings ratio assigned to the sector in 2000. Equally important, valuations are below long-term trend. At a multiple of 15 times, the index is 5% below its 10-year average and 3% cheaper than the entire S&P 500. Historically, the sector has traded at a 14% premium to the broader index.
A rosy outlook
However, valuations alone only tell half the story. The other half lies in the IT companies’ considerable strength and potential. Further underpinning the sector is the spending outlook for enterprises that had delayed investment in technology during the past few years of economic adjustment. On one hand, companies have even more legitimate reasons to increase capital expenditure: improving global final demand, aging plants and equipment, and access to low-cost financing. On the other hand, innovations in the sector are gaining market penetration and have become secular drivers of growth: cloud computing, big data, e-commerce, and mobile computing.
A recent UBS survey of corporate chief information officers shows that more than 60% are more optimistic about increasing spending; the majority of the spending will likely be allocated to long-term IT architecture requirements; and enterprise IT spending will grow 7.7% over the next 12 months. The improvement in spending outlook comes not only from the US, but also other developed markets such as the UK and France.
We believe the software industry is a key beneficiary of such a pick-up in IT spending as we see strong pent-up software demand. Another reason we prefer the industry is its high recurring revenue base and above-average margin profile.
A recent trend worth highlighting is the rise of wearable technologies. Despite being in their early stages, ‘wearables’ could be a long-term growth driver for the IT sector, as the broader trend of ‘Internet of Things’ (IoT) takes off. This refers to the ability of everyday objects and devices to communicate and exchange instructions over a network. Driven by strong demand from consumers and industries such as healthcare, utilities, manufacturing, and transportation, IoT devices could see solid growth over the next few years, up to an annual growth of 43%, in our view.
The best ways to play the theme is through semiconductor companies exposed to sensors, microcontrollers and communications, as well as select software and Internet companies.