This article is part of Fortune‘s quarterly investment guide for Q1 2021.
Even the casual market observer could recognize that 2020 was all about the tech trade.
So-called work-from-home stocks, those enabling consumers and businesses to operate socially distanced, skyrocketed last year—with the tech sector’s rally outpacing the overall S&P 500 by more than double.
But now that the vaccine has arrived on the scene, market prognosticators can finally see beyond the pandemic. And they’re not shunning the tech trade. “The world has changed for good,” says Cathie Wood, the founder and CEO of tech-focused investment manager ARK Invest. “When businesses and consumers adopt new technologies that are cheaper, more convenient, faster, more creative in their response, there’s no turning back.”
Yet investors may wish to be turning back from the high valuations that have increasingly accompanied names in the tech sector, boosted by near-zero interest rates that are likely to stick through 2021. (The S&P 500 tech sector’s forward P/E, for example, is at 28 times earnings, versus 23 for the index at large.)
But for those investors concerned that rising share prices and rapid growth will inherently limit the upside, Gary Robinson, a portfolio manager at asset manager Baillie Gifford’s U.S. Equity Growth Fund, offers a caveat: “There’s often the temptation to say, ‘This is the fastest this company will ever grow, and next year it will grow slower,’” he tells Fortune. “I think the exceptional growth companies are less likely to ‘mean revert’ because…they’re investing in huge market opportunities, and so they’ve got headroom to grow unimpeded for very long periods of time.”
To be sure, there are pockets in the tech space that have gotten ahead of themselves in terms of valuations, investors say. That’s why those like Sung Cho, a portfolio manager of the Technology Opportunities Fund at Goldman Sachs Asset Management, says he’s been shifting its portfolio toward more cyclical-recovery stocks like those levered to small and medium-size businesses, payments, and semiconductors.
Coming off such a big year, Fortune asked portfolio managers which tech names they have faith can do well even after much of the world emerges from lockdown—the kinds of names tethered to accelerating trends that aren’t likely to stall out.
The semiconductor play
Semiconductor stocks overall had a great run last year, but according to money managers, companies in the space are only just scratching the surface of what’s to come for the cyclical sector.
“Where we’re seeing the winners going forward will be those companies that are exposed to these faster growth trends,” says Lori Keith, who manages the Parnassus Mid Cap Fund.
As a semiconductor process control company, Keith thinks KLA Corp. (KLAC, $314) is “poised to benefit as we see these trends play out,” including the accelerating shift to cloud, 5G, and the use of semiconductors in the automotive sector. “Automotive unit vehicles have been [hit] during the pandemic [as] people weren’t doing as much driving,” notes Keith. “But when you look at the shift over time as we move toward more [electric vehicles], hybrids, plug-ins…there’s a significant amount of semiconductor content in the areas of things like safety and advanced driver assist features, sensors—all of that is going to drive significant growth.” KLA Corp., which Keith notes has dominant market share and very strong free cash flow and R&D, provides “mission critical” technology for semiconductors, and should only benefit from the increasing complexity of chips going into autos, medical devices, and cloud data servers. “Those all require very significant amounts of testing to make sure [of] the reliability,” says Keith, which should boost KLA Corp.’s business. Plus, the stock trades at roughly 24 times forward earnings—a far less expensive price tag than many of its high-flying tech peers.
For investors searching for a name with a “pristine” balance sheet and a mix of “defensive and offensive characteristics” that should outperform “regardless of the economic cycle and the timing of the economic recovery post-COVID,” portfolio managers like Parnassus’s Keith favor Synopsys (SNPS, $268), an electronic design automation software company used by semiconductors to design chips. One big growth lever going forward is the company’s broadening user base into what Synopsys calls systems companies: “It’s the Internet companies; it’s the auto companies,” notes Chul Chang, a portfolio manager and research analyst for Vontobel’s Quality Growth Boutique. Another area that’s seeing a boost: intellectual property. As many semiconductor companies increasingly focus on more complex chips, they have started to “outsource a portion of their noncore chip design,” notes Keith. That has helped Synopsys “grow their IP business at a rapid clip,” and provides a “significant runway for multiyear growth,” she suggests. The company is expected to see steady growth this fiscal year (the Street estimates revenues will increase over 9%), and it is armed with a $4.9 billion backlog of multiyear contracts as of the final quarter of 2020. Trading at around 43 times forward earnings, its valuation is “a little punchy,” says Chang, “but from a long-term growth perspective we’re pretty comfortable.”
But all those innovations need to be tested along the way. That’s where Keysight Technologies (KEYS, $147), a testing and measurement equipment provider for electrical and radio signals, comes in. Keysight makes “critical tools that companies are unlikely to skimp on” and that become “sticky” once users get accustomed to them, says Vontobel’s Chang. He notes the “big theme with Keysight currently is 5G—the testing needed around 5G, but also what 5G is going to be doing for [the Internet of Things], for A.I., for the auto sector.” Like KLA Corp. and Synopsys, Chang argues Keysight’s tools will be important in building up the infrastructure for electric vehicles and testing everything from the charging mechanisms to the batteries. “There’s a lot of growth levers here,” Chang says. The stock currently trades at a reasonable 27 times forward earnings, with revenues expected to grow over 11% in fiscal 2021.
Turbocharged trends
Plenty of industries have been turbocharged last year, with their applications and adoption skyrocketing as businesses and consumers flocked to their services in an increasingly digital world.
Among such areas seeing growth is the payments space. “We’re bullish [on] the payments sector for several reasons: In addition to cyclical tailwinds from an improving global economy, the growth is going to be supplemented by lots of new payment flows and the potential for China to open up as a new market for foreign payment players,” Goldman’s Cho tells Fortune.
Those payment flows, like peer-to-peer, business-to-business, and even cryptocurrency, have gained traction during the crisis—even being utilized by the government to send stimulus payments. In 2021 “we think there’s a fundamental acceleration that’s likely to be sustained,” Cho says. “You can really see a supergrowth cycle on top of the cyclical recovery for the payments sector.”
One stock poised to continue benefiting from such trends is payments behemoth PayPal (PYPL, $247). The company is growing its user base by leaps and bounds, and analysts expect revenues to increase 19% in 2021. But ARK Invest’s Wood particularly likes the name for its growing China exposure: PayPal recently obtained full ownership of Chinese payments company GoPay, which it first acquired in late 2019, continuing to expand its reach in the key Chinese market in addition to its partnership with Chinese card issuer UnionPay. And given the firm’s earlier partnership with MercadoLibre in Latin America, PayPal is “really going to scale globally,” says Wood.
The boom in the payments space also benefits Jack Dorsey’s Square (SQ, $227), whose Cash App business (which allows users to send money and even trade Bitcoin) has been a big revenue-driver during the pandemic. But with many small businesses (Square’s original bread and butter through their point-of-sale devices) having suffered amid shutdowns, ARK’s Wood sees some post-pandemic upside. “We know that a lot of small businesses are going to have the opportunity to get back to work, and we think Square could be one of the biggest beneficiaries of that.” Though it trades quite expensively (with an over 200 forward P/E), analysts expect the firm to grow revenues by 40% in 2021.
One area Vontobel’s Chang feels “everyone can agree [on], whether it be pre-COVID, post-COVID,” is that the “continued digitization of the world and data proliferation is definitely not slowing.” One stock “smack in the middle” of that digital transformation theme is Adobe (ADBE, $457). The digital marketing software company, known for key products like Photoshop, had a healthy 2020, but Chang believes there’s plenty of room for further growth (the Street estimates revenues will increase 18% this year). In particular he points to Adobe’s recent acquisition of Workfront, to better “marry the content and the marketing a little bit” through workflow automation, and he notes the firm’s PDF and e-signing business should be able to build on the “impressive” growth it saw last year. The stock trades over 40 times forward earnings, still off 14% from its 52-week high, while Adobe also just authorized a $15 billion share buyback plan through 2024.
The 2020 winners
Even as the world is in the midst of its long trek back to “normal” in 2021, portfolio managers still see upside in a select few beneficiaries of the pandemic.
According to Baillie Gifford’s Robinson, “When you look at where we’re at in terms of the shift online, there’s still a tremendous amount of growth ahead for these platforms; it’s still relatively early,” he argues. Those platforms include Shopify (SHOP, $1,174), the all-in-one e-commerce platform for entrepreneurs. Robinson notes Shopify has continued to innovate and add new products throughout the pandemic, like its fee-free business account for merchants. What’s more, ARK Invest’s Wood believes “retailers are looking for a way to move away from Amazon, or they’re looking for a much less expensive way to participate in the social commerce movement,” where social media platforms play a role in selling products. She thinks Shopify “is an important answer to that.” (She points to TikTok’s recent partnership with Shopify.) Though it’s trading at sky-high levels, the Street expects Shopify to still grow revenues at a healthy clip (33% this year), while the stock is off roughly 8% from its highs.
Ever the contrarian, ARK Invest’s Wood is not one to shy away from a counter-consensus call. She still sees upside for Zoom Video Communications (ZM, $394), the videoconferencing company that has become a workplace staple during the pandemic.
There’s no denying the stock is trading at pricey multiples after its over 395% trek higher in 2020. But Wood notes in recent months Zoom’s share price has been “cut in half” from its highs. That selloff, argues Wood, may be because “many people are worried that once we go back to work, Zoom’s raison d’être will disappear. We disagree entirely with that,” she says. Instead Wood believes more people will continue working remotely post-pandemic: “Even if one person in an office is working remotely, then everyone has to be enabled with Zoom in and outside of work,” she adds. Plus, Wood points to recent reports that the company is developing new email and “more Microsoft-type functions” that could help Zoom compete in more areas. Trading around 31% below its 52-week high, investors may be tempted to take a leap of faith.
All stock prices calculated as of Jan. 19, 2021.
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