Income vs growth in technology investing

You won’t typically see a lot of technology stocks in an income portfolio, says Dan Roberts, manager of Fidelity Global Dividend. That’s because many of the big name companies don’t tend to pay dividends, instead reinvesting their profits for future growth. But Dan suggests income seekers who ignore the sector entirely miss an attractive opportunity.

“‘Boring’ companies can offer exciting return prosects,” he says. And not every firm in the sector is a fast-growing, fashionable FAANG (Facebook, Amazon, Apple, Netflix and Google) wannabe, he goes on to explain.

“There are a variety of more mature businesses too, which have ‘grown up’ to dominate their fields and display a number of attractive attributes: well-established, diversified businesses; recurring revenue streams with plenty of cash on the balance sheet; proven track records; and a strong history of paying consistent dividends.

“The tech sector has proven to be a relatively fertile hunting ground for Fidelity Global Dividend since it ¬launched back in 2012. Today, the sector accounts for around 11% of the overall portfolio, but I focus on what we would term ‘old’ tech stocks.”

Less glamour, better valuations, more income

Dan refers to these as “the growth stocks of yesteryear”.

“It is an area that looks less exciting than the new wave of tech giants, but provides a more interesting opportunity set for valuation-aware dividend investors. As prospective growth rates [for some of these businesses] have fallen, valuations have become even more attractive. This is in stark contrast to the FAANG stocks, where it is questionable whether there is sufficient earnings support in the underlying businesses to warrant current valuations.”

Microsoft is an example of what Dan considers an ‘old’ tech stock and he says it has been a significant holding in the fund since launch.

“It still enjoys a very strong market position in the PC industry where the Windows operating system and Microsoft Office continue to generate enormous profits. While individuals may switch to cheaper or free products at home, the cost to businesses of switching remains high.”

Dan also highlights a US semiconductor manufacturer KLA-Tencor, which he bought nearly a year ago in October 2016.

“It is a world leader in its space and is therefore ideally positioned to benefit from the strong demand of smartphones and tablet manufacturing, for example. At the time of purchase, KLA offered many of the characteristics that we look for in a stock. And, like Microsoft, the strength of its underlying business, steered by a capable management team, means it is well positioned to sustainably grow both its earnings and dividend payments to shareholders over time.”

Technology growth from other industries

Furthermore, given concerns around valuations in technology’s poster children, even growth-oriented managers are casting their net wider than the favoured FAANGs. Technology growth doesn’t necessarily need to be led by ‘technology’ stocks.

Three industries where new technology will impact investors

Disney, for example, recently announced it will launch its own internet streaming service in 2019. This dealt a blow to Netflix, which currently has a contract to show Disney films as a part of its content offering. However, Disney also said it would create a similar online streaming platform for its sports network, allowing the company to cut the cord completely with its cable TV model.

After decades of unassailable dominance, US cable conglomerates have finally been meeting sustained competition from the likes of Amazon, Hulu, Netflix, Fox and others. If Disney managed to add sport to the online offering, it might truly signal the beginning of the end for the cable business model.

James Thomson, who runs Rathbone Global Opportunities, is one manager who actively positions his fund to benefit from this kind of growth potential. He favours disruptive, entrepreneurial businesses and holds around 22% of his fund in technology stocks – but also looks for companies with technology advantages in other industries, such as financials and health care.