Disruptive Technology – Staying the Course in Volatile Markets
Here, we review the risk factors, opportunities, and key areas of debate. We also take a closer look at the potential of semiconductors as a key foundational technology for digital transformation.
Several major risks remain for growth and technology stocks.
We have seen a significant rotation from growth stocks to value stocks, largely due to rising inflation and rising interest rates. This rotation could continue.
Many high-growth companies that invest heavily in product and sales capacity are longer-lived assets with more of their cash flow generation projected farther into the future than is the case with companies with more stable growth and value. These stocks have recently suffered a significant contraction in their price/earnings multiple.
Recession risk is rising as the US Federal Reserve and other central banks tighten financial conditions to fight inflation. In addition, the Russian-Ukrainian conflict and associated sanctions against Russia are creating macroeconomic headwinds. Tariffs, Covid-19 response measures, semiconductor shortages and freight bottlenecks are all fueling supply chain disruptions.
Finally, in the “Big Tech” sector, there are risks associated with antitrust and other forms of regulation.
Despite these risks, we see many reasons for optimism. We are confident in several long-term secular growth themes that are fueling the digital transformation of the economy. We believe companies will continue to invest if they see digital transformation as an imperative to stay competitive.
For example, the adoption of cloud computing continues to accelerate. IT research and consultancy Gartner raised its projection for 2022 to $500 billion, 37% higher than the level projected in November 2020.
Additionally, we are witnessing the growing adoption of artificial intelligence (AI), which is becoming a foundational technology with a proliferation of applications, automation, the Internet of Things (including edge processing – the processing data closer to its source to reduce delays by minimizing communication time between “clients” and servers), and financial technology.
Disruptive technology trends enable the creation of new products, services and business models. They make operations more efficient. In short, they are transforming the way we live and work.
One of the main debates in the sector is to what extent the increased demand of the first two years of the pandemic is sustainable. For example, e-commerce growth is returning to pre-Covid levels as shopping and in-person experiences resume.
A second major issue is whether valuations have been squeezed “enough”. We are seeing attractive valuations across all of the companies we monitor. We believe companies that lead and/or benefit from digital transformation and associated secular growth themes will deliver strong revenue, earnings and free cash flow growth over a long investment horizon.
Most of the multiple compression comes from the higher growth cohort, where multiples are now down 72% to 10.6x, based on data from companies expected to grow annual revenue by 30% or more . The slower growth cohort (projected annual sales growth of 15% or less) is now trading at 4.4x, which is 20% below the average of the past 5 years and in line with the 2014-2018 average.
Out of Consensus – Semiconductor Super Cycle
In the semiconductor segment, we strongly believe that the secular growth drivers are so compelling that any inventory correction is likely to be short-lived and unlikely to impact all industry segments simultaneously. We are comfortable with our overweight position to maintain our exposure to positive long-term trends.
Currently, demand for semiconductors far exceeds supply despite evidence of slowing sales of personal computers and smartphones. Thus, the industry might be able to absorb a mild recession without falling into oversupply.
We believe that the main drivers of increased demand for semiconductors are the secular growth trends that underpin digital transformation. Semiconductors are a fundamental technology for cloud, AI, automation and IoT. Industry end markets have expanded from mainframes to PCs, smartphones, and now diverse industrial, automotive, and high-performance computing applications.
This diversification helps to reduce volatility in industry demand because no single end market dominates.
On the supply side, the structure of the semiconductor industry has improved significantly. The advent and success of the foundry business model enabled innovation and concentrated manufacturing among fewer companies.
The supply of memory chips has also been consolidated with a handful of manufacturers. This has resulted in more strategic capacity decisions and less risk of structural oversupply. Growing capital intensity and technological complexity are significant obstacles for new entrants.
Looking ahead, we see the potential for continued strong growth for the semiconductor industry, driven by automotive and high performance computing (HPC) applications.
Secular growth and attractive valuations
In recent months, the market environment has been difficult for growth and technology investors due to macroeconomic headwinds.
However, the digital transformation of the economy will continue and we remain constructive on the secular growth drivers that underpin this trend. Valuations look more attractive following the recent correction and we remain committed to our investment philosophy.
References Also listen to Talking heads – Staying the course despite the volatility of disruptive technologies – Investors’ Corner (bnpparibas-am.com) with Pamela Hegarty  Morgan Stanley, Keith Weiss – May 15, 2022 – ‘Evaluation views 15-05-2022: Bouncing off the bottom‘
Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience.
All opinions expressed herein are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may have different views and make different investment decisions for different clients. This document does not constitute investment advice.
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