ASX tech index has further to rise

The technology index has been performing strongly on the ASX and its rally looks like it has much further to go. The question though, is how far?

Jun Bei Liu of Tribecca Investment Management. Picture: Renee Nowytarger

The tech-heavy US-based Nasdaq produced an impressive 50 per cent return over the past 12 months and although the Australian sharemarket has bounced back in recent months, it has achieved nowhere near the gains that we’ve seen in US markets.

But inside the modest returns from the wider ASX there has been very little attention given to one standout sector – the local IT index.

Going back to 2015, the Australian listed technology sector suffered a large setback when homegrown success story Atlassian opted to bypass the Australian sharemarket and list on the Nasdaq in a $650m IPO.

The rationale behind the US listing was access to larger capital markets – although the Atlassian IPO was well below the size of Australia’s largest IPO which was Medibank Private, which raised $4.7bn in its ASX listing.

And after suffering a 45 per cent peak to trough drop in 2022, as interest rates soared to combat high inflation, the Australian technology sector has produced an impressive bounce back, beating its US counterpart having returned 53 per cent over the past 12 months.

The ASX 200 Information Technology index comprises Australia’s biggest technology companies such as Wisetech Global, Xero and NextDC.

Tribeca Investment Partners Lead portfolio manager Jun Bei Liu says: “The Australian technology sector is still in its infancy and has incredible companies that are taking their services global such as Xero.

“Although some of the Australian tech companies are being bought and being removed from the ASX, such as Altium, there are still a lot of promising companies still coming through.”

The stumbling block for some investors is that they like stocks that generate strong profits, substantiating their valuations and paying healthy dividends.

Investing in listed technology is like a leap of faith. You are betting on the company hitting certain milestones and delivering upon their ambitious growth plans, which to a large degree is already factored into the current share price.

The ASX long-term average price-to-earnings ratio is approximately 15 times and some of Australia’s largest technology companies trade on substantially higher PEs; Xero has a PE of 85 times, WiseTech is 88 and Pro Medicus is 106.

In other words, despite the substantial potential upside in technology companies, if they miss their growth targets, there is a long way for them to fall in price.

This is illustrated by the 99 per cent peak-to-trough drop in Australian data solutions and AI company Appen, which fell from over $30 in 2020 to under $1 today after they missed revenue and profit targets.

More recently, Appen has received a takeover offer from Nasdaq-listed Innodata, although this bid has since been withdrawn.

Wilsons Advisory equities analyst Rob Crookston says: “Strong earnings growth will in all likelihood be the main driver of continued outperformance in the technology sector.

“Additionally, potential rate cuts by the Fed later this year and the likelihood of lower bond yields could create a tailwind for growth-company valuations.

“These factors combined suggest tech stocks are well placed to keep outperforming the broader market over the medium term.”

Investment partner Sam Byrnes at ECP Asset Management agrees and says: “ Despite the rerating over the last 18 months, many technology names still have reasonable valuations relative to their long-term potential.

“It is critical, however, to be discerning about stock selection as there is a wide dispersion in quality among listed technology names.

“We are also seeing signs that AI is starting a new customer buying cycle, and companies like HUB24 and Xero are utilising this new technology to improve their customer experience and operating efficiency – which we believe can continue to deliver long-term value creation.”

And speaking of AI, on the back of the success of graphics processing unit maker Nvidia, there is now a heightened interest from investors to gain an exposure to AI but without paying sky-high prices. One potential avenue is to invest in data centres.

“With the commercial application of AI growing, the use of data has grown exponentially. NextDC is Australia’s biggest data centre provider with over 20 locations across Australia, Japan and Malaysia,” Jun Bei Liu says.

Another Australian company which is taking up the AI boom by growing its data centre capabilities is Goodman Group. Although you would typically associate Goodman Group with warehouse investments, it is now pushing to become a global powerhouse in data centres and 30 per cent of its $13bn global project pipeline is in constructing data centres across 12 cities.

We are at an interesting juncture for the Australian technology sector; has it hit a short-term peak, or is this just the beginning of a growth megacycle propelled by the AI boom and supportive economic conditions such as falling interest rates and lower bond yields?

Either way, investors need to appreciate the heightened risk return metrics which Australian technology companies exhibit and decide whether they pick a portfolio of individual stocks such as Xero and WiseTech, or purchase a tech ETF such as the Betashares S&P/ASX Australian Technology ETF (ASX: ATEC).

James Gerrard is principal and director of Sydney financial planning firm www.financialadvisor.com.au