Marlborough's Jeffrey Lum says the technology sector can offer handsome returns for investors
When Apple co-founder Steve Jobs proudly unveiled the company’s latest wonder product, the iPad, in front of the world’s media in January, it was not only the hardcore gadget enthusiasts who were smiling.
If demand takes off for the touch-screen tablet computer, which is designed to fill the gap between smartphones and laptops, it will be good news for companies in the technology sector.
Analysts calculate for every 1.5 million to two million iPads sold the demand for Dynamic Random Access Memory (DRAM) chips will increase by approximately 3%. That means bigger profits for the largest producers, the manufacturers in Asia.
For investors, the technology sector can offer handsome returns. If a company has the right product, customers will literally queue up to hand over their cash. And the benefits flow right down the supply chain.
But the product has to be right. Do not forget for every iPhone sold there are plenty of less-popular competitors sitting ignored in a display cabinet.
Life after the bubble
Remember too this is a sector that can become overheated. The technology bubble that burst in March 2000 serves as a warning to any investor who thinks the only way is up for companies in this sector.
But 10 years on from the bubble, technology once more looks a highly attractive arena for investment. And nowhere more so than in the manufacturing heart of the sector, Asia.
In Asian markets the time has come, we believe, to reduce holdings in banks, after their strong performance last year, and increase weightings in technology, particularly in countries such as Taiwan and Korea.
The technology sector is an investment arena where experience is invaluable. Good fund managers understand the importance of choosing the right time to take profits, because this is a highly cyclical environment. When a lucrative new market emerges, companies have a tendency to spend heavily to secure their share of the market. Eventually margins fall and as a result share prices drop. So timing is crucial.
The other key element is, of course, choosing the right companies in the first place. Shrewd investors will focus on three questions when they consider buying a stake in a technology company. In very broad terms these are: is there a demand for what they produce? What is the supply situation? And what is the valuation?
Demand
In terms of demand, Samsung is extremely well-positioned at the moment, with strong performance looking likely in three key areas: DRAM memory chips, LED television sets and smartphone handsets.
The launch of the iPad will have brought smiles in the Samsung boardroom. The South Korean giant is a world-leader in DRAM technology and the largest producer in the market, with another South Korean giant, Hynix, in the number two spot.
That though is far from the only reason demand is looking healthy in the technology sector. For many companies, upgrading their IT systems was firmly off the agenda during the downturn.
Now, with the recovery taking hold and an enthusiastic uptake of Microsoft’s Windows 7 – after a lukewarm reception for Vista – more and more businesses globally are replacing their computers with new models.
Already bellwether stocks such as Cisco, the world’s largest manufacturer of networking equipment, are showing strong performance and the prospects look good for Asia’s DRAM manufacturers.
Computers are only one facet of technology, of course, and the television market is a highly lucrative one, particularly in a World Cup year. Superior picture quality and greater energy efficiency mean sales of LED sets have outstripped market forecasts and early investment in this technology has, again, given Samsung an edge over the competition.
Given the consumer appetite for LED televisions, the equipment required to manufacture these sets is also in great demand and producers such as Hong Kong-listed ASM Pacific Technology are also well-placed to deliver strong returns.
Samsung sold 5.7 million smartphones in 2009, capturing 3% of the global market, and intends to at least treble this in 2010 by offering handsets running on Google’s Android, Windows Mobile and Linux, as well as its own software platform, bada.
So the prospects for demand look positive. One concern is buyers will be swamped by oversupply, meaning profits will suffer. This though looks unlikely. In the wake of the downturn, many technology companies are taking a cautious approach to building more production lines.
No manufacturer wants to be left with enormous over-capacity when recovery in many of the largest markets is still slow.
Valuation
The final item on our technology company checklist is valuation. Across the technology sector, price to earnings ratios are looking relatively low. While the reasons for this are many and varied, by isolating one factor affecting valuations – concerns about labour costs – we can highlight the importance of selecting the right companies for a portfolio.
For many technology companies, China is an important manufacturing centre because of the availability of comparatively cheap labour. However in Beijing and China’s coastal provinces – where many of the world’s technological products are produced – a tightening labour market means there are moves to increase the minimum wage. Indeed, Jiangsu province has already decided on a 13% increase.
Ahead of the game
One company staying ahead of the game, and looking attractive as a result, is Taiwan’s Hon Hai, which assembles the iPhone for Apple. It has not become the world’s largest contract manufacturer of electronics without keeping a close eye on labour costs and is already in the process of shifting production from China’s coastal provinces to inland factories.
While China is keen to close the technology gap, in Asia, at least, Korean and Taiwanese companies are, for the time being, maintaining their lead and looking the most attractive from an investment point of view.
Looking to the future, while forecasts are never easy, particularly in a sector as fast moving as technology, we can be certain of one thing, innovation will continue. However successful the iPad, soon enough there will be a successor. And that will mean more contracts for Asia’s technology companies.
Jeffrey Lum is manager of the Marlborough Far East Growth fund
