What's next for the tech industry?

PGIM Investments

Disruptive technology

August 2018

Key Points

  • Top technology stocks have driven positive market performance
  • The industry appears to offer continued growth potential but not without overcoming some hurdles
  • The rapid growth of top technology companies has increased regulatory scrutiny, which may present growth risks

Many investors remember the explosive growth of internet startups in the late 1990s and early 2000s. These stocks experienced a period of extreme growth before the bursting of the dot-com bubble in March 2000 that caused technology stocks to lose significant ground.

Who can forget the companies Yahoo and America Online? After reaching tech titan status in the late 1990s, they’re now both owned by Verizon Communications. How about Pets.com? It had a high-profile marketing campaign but was liquidated in November 2000. Nearly 20 years later, we’ve entered a new age of innovation and growth in the technology sector.

The latest technology boom

Disruptive technologies are transforming the way people around the globe communicate, shop and enjoy their leisure time. Technology innovators are challenging traditional industries that have existed for decades.

Technology stocks overall have been strong performers of late. Should investors worry about another tech bubble similar to what happened after the boom era of the 1990s? It’s a legitimate consideration, but one factor to keep in mind is that the technology sector isn’t monolithic. Their stocks aren’t likely to behave uniformly.

Have technology stocks become overpriced?

There is a concern that technology stocks are becoming overvalued given their performance trends. While they have performed well recently, in terms of valuation, technology stocks overall are much less expensive now than during the dot-com era of the 1990s.

Consider the price-to-earnings (P/E) ratio, a key measure of whether a stock or sector currently offers value or is potentially overpriced. The P/E ratio for the technology sector is below the long-term average of the overall market, which indicates that current stock prices are in alignment with the stocks’ value. The prices are meaningfully lower than they were in the early 2000s when this sector suffered a significant decline.

Certainly, select technology stocks have reached pricey valuation levels. Yet a case can be made that in some instances, high short-term valuations are warranted for companies that have the right stuff to thrive and transform the economy. Investors should keep in mind that such momentum-driven technology stocks may also carry a higher degree of risk.

Growth in the technology sector

As a whole, the technology sector represents about 26% of the S&P 5001 and has seen a 16.6% increase in total returns so far this year.2 Comparatively, the S&P 500 has experienced a 7.9% total return year-to-date.2

Facebook, Amazon, Apple, Netflix and Google (Alphabet), referred to in the financial media as the FAANG stocks, are currently the most prominent players in the technology arena. These giant tech companies are at the vanguard of recent disruptive innovation, but have they become overvalued?

Any number of variables are likely to come into play in the months and years ahead to answer that question. Let’s look at some of the key drivers of various technology industry segments that are likely to be critical to the ongoing growth of this sector.

Communication in the social network age

Leading online social networks have profoundly changed how we interact with friends and family and the way we consume news and entertainment. Their broad usage has increased appeal for advertisers and provide these businesses a stable source of revenue.

While growth potential remains strong, recently concerns have been raised about how effectively some firms protect the private information of users. An increased focus on this issue could create potential regulatory and revenue hurdles for social media companies.

The changing retail landscape

Online shopping has transformed how, when and where we shop. While growth in the traditional global and U.S. retail industry is steady, e-commerce sales continue to increase rapidly. They comprise an ever-larger portion of the overall retail market as brick-and-mortar sales decline.

There are rumblings that some companies may be getting too large too quickly and that there could be regulatory battles down the road. One example of this can be seen with the new requirement that online retailers collect state sales taxes, which is a requirement most retailers have to follow. Online shopping is expected to continue its rapid growth as e-commerce expands globally.

Newer, faster and smaller devices

Sleek, eye-catching computers and mobile devices have given consumers groundbreaking ways to access, consume, monitor and share information, images and entertainment. It is reasonable to expect that we’ll continue to see breakthroughs in new technology in the years ahead. However, this area of innovation remains very competitive, and today’s top-performing firms are constantly challenged to maintain their leadership position.

Investors should understand that momentum-driven technology stocks may also carry a higher degree of risk.

Rapidly-flowing streaming services

Streaming services have transformed how, where and when we consume entertainment. Subscription-based streaming media services and a burgeoning lineup of television programs and movies are now readily consumed thanks to improved internet streaming capabilities. Streaming services have generated impressive subscriber growth, although continued expansion will likely be increasingly reliant on overseas markets.

Information at a keystroke

Internet search engines have sparked a seismic shift in the way we access information and spend money. This industry continues to evolve as new capabilities such as artificial intelligence help improve the level of service they can provide. One of the major challenges for the industry is the ability to replicate the rapid rate of past revenue growth.

Tech stocks within a diversified portfolio

While prominent in today’s market, the technology sector is only one industry in the broad investment landscape. It is important to have investments that are properly diversified within a portfolio that accurately represents your risk profile. The technology sector has proved capable of generating sizable gains in recent years and over time. Like any segment of the stock market, it is also subject to short-term price volatility. It is important for investors to remember that not all tech stocks will perform in the same manner.

As you work with your advisor to structure your portfolio, consider any investment in the technology sector to be a long-term investment. Talk to your financial advisor to determine the most appropriate role it can play within your asset mix and how it fits with your goals.

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