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Since our last update where we upgraded the Digital Economy to 4.0 Stars “Very Attractive”, our recommended ETF, the Invesco NASDAQ Internet ETF (NASDAQ: PNQI) is up by 12.4%.
Earnings for the tech sector is growing strongly, bolstered by various demand drivers, particularly Artificial Intelligence (AI).
The potential of AI is accelerating, and the demand for AI solutions particularly benefits the cloud segment, with Big Tech players such as Amazon, Microsoft, and Alphabet being beneficiaries.
Big Tech companies stand out due to their formidable competitive advantages and wide moats, enabling them to further strengthen their brand influence and growth.
The strong performance of the technology sector is expected to continue in 2024. Based on our fair PE multiple of 30X, we arrive at a 2026 target price of USD 53 for the Invesco NASDAQ Internet ETF (NASDAQ:PNQI), implying a 37% upside. We maintain our 4.0 Stars “Very Attractive” rating for the sector.
The technology sector kicked off 2024 on a strong note.
Since our last update in November 2023, where we upgraded the Digital Economy from 2.5 Stars “Neutral” to 4.0 Stars “Very Attractive”, our recommended ETF, the Invesco NASDAQ Internet ETF (NASDAQ: PNQI), is up by 12.4% as of 24 April 2024 even despite a recent pullback (Figure 1).
Figure 1: Performance of PNQI
The upgrade was built on our core thesis that the technology sector, particularly the Big Tech companies, has already weathered an earnings recession and undergone massive cost-cutting initiatives, marked by a surge in layoffs in 2022 and early 2023 before tapering off towards the end of 2023. More importantly with the rapid growth of the digital economy, these companies are set to become more important than ever.
Despite our view that interest rates would remain higher for longer, we believe that the growth trajectory of the Big Tech companies would not be as affected due to their strong balance sheets and cash generating abilities. Furthermore, these companies are set to reap the benefits of megatrends such as cloud computing and artificial intelligence (AI).
Although the share prices of several technology names are trading near all-time highs, we continue to hold a positive view on the technology sector, particularly the Big Tech companies. The recent pullback in share prices also presents investors with an opportunity to invest.
Related article — The earnings recession is over. Big Tech is set to lead the next phase of growth.
Earnings growth is gaining momentum
After a period of decline, Big Tech companies are making a strong comeback. All of them exceeded analyst expectations during their 4Q23 results. Currently, Big Tech companies are set to report their earnings this week and the next, which we will be watching closely.
Looking at these companies, net incomes have accelerated back into double-digit territory across the board after rebounding from the earnings recession in 2022, with the exception of Apple, which is facing some headwinds in China (Figure 2). In particular, cloud platforms with strong AI integration, such as Microsoft Azure and Amazon Web Services, are experiencing impressive growth, highlighting the potential of AI in the tech sector.
Related article: Big Tech 4Q23 Wrap: The Rally Continues
Figure 2: Earnings growth for Big Tech
has already bottomed and is gaining momentum
The exceptional performance of these Big Tech companies is expected to continue as we head towards the second half of 2024, despite higher base effects as compared to 2023, driven by artificial intelligence (AI), cloud computing and continued cost cutting efforts to improve operational efficiency.
Beyond Big Tech companies, expectations for earnings growth within the broader technology sector for 2024 and beyond is also expected to come in strong. Collectively, the technology sector is projected to grow earnings by 25.0% year-over-year (YoY) this year, surpassing the S&P 500 Index. Meanwhile, the Big Tech companies are expected to experience even stronger growth, with earnings forecasted to increase by 26.9% YoY in 2024.
Figure 3:
Technology sector expected to outpace the earnings growth of the broader
market
Demand for AI solutions particularly benefits the cloud segment
2023 was a breakout year for large language models (LLMs), such as ChatGPT, Microsoft Copilot and Google’s Gemini, which use machine learning (ML) techniques to understand and generate new text content. These models demonstrated the utility in enhancing user experience and business efficiency.
The adoption of AI is only set to grow, creating many opportunities within the tech sector. For instance, the AI frenzy led to a resurgence in cloud growth, which materialised during this earnings season. Microsoft's Azure, Amazon's Web Services (AWS), and Google's Cloud Products all surpassed growth expectations in the fourth quarter.
Revenue at Azure grew by 30% YoY in the latest quarter, while AWS grew by 13% YoY. Meanwhile, Google Cloud’s revenue grew by 26% YoY, and generated operating margins of 9.4%, a massive improvement as its operating income swung from a loss of USD 480 million in 4Q22, to USD 864 million in 4Q23. Management from these companies have also expressed optimism in their forward guidance, pointing towards the growing traction in cloud services for artificial intelligence.
Related article — Alphabet: Time for this underappreciated Big Tech stock to shine
With the growing adoption of AI, the big three hyperscalers (Amazon, Microsoft and Google) which accounted for 67% of the worldwide market (Figure 4), are set to experience an uptick in demand for their cloud servers. To meet this demand, Amazon, Microsoft and Alphabet are ramping up capital spending to build up capacity. The collective cloud-related capital expenditures of these three companies is expected to reach USD 116 billion this year, representing a 22% increase from last year. Profits from their enterprise business segments are expected to soar with corporate customers paying for services like cloud and software platforms or devices to use in their workflow.
Figure 4:
Big Three continue to dominate the cloud market
Over the longer-term, the global cloud infrastructure market is expected to further grow from USD 233.9 billion in 2023 to around USD 653.9 billion by 2032, expanding at a CAGR of 12.1%, seeing that many AI tools require vast amounts of datasets. The bottom line is that as more companies seek to incorporate AI and store their data in cloud storage, Big Tech companies, which serve as both enablers and beneficiaries, would gain tremendously, resulting in higher revenues and profits.
Big Tech’s strong competitive advantages enable them to further expand their brand influence
Looking ahead, we think that within the technology sector, Big Tech companies are able to further expand their reach due to their strong competitive advantages, which include having wide moats that fend off competitors as well as a sustainable and global business model. Besides, their strong cash reserves are worth highlighting, as it enables them to further strengthen their reach by acquiring or making investments in promising up-and-coming companies.
Figure 5: Big Tech companies have amassed
a ton of cash reserves
Today, some of the most durable moats are built on advantages like network effects and data within a product or service ecosystem, which are precisely what Big Tech companies are known for. Products and services offered by these companies have also become deeply entrenched in the daily lives of consumers and corporates. It would be difficult to imagine how the world operates without Google, Microsoft Office or Amazon Web Services.
Their huge base of users further gives them a stronghold in today’s world. For instance, Meta is the largest social network in the world with 3.59 billion users, or more than 77% of internet users, while Google has a monopoly in online search with a 92% market share. Together, more than 50% of global digital ad spending now goes through Meta or Alphabet, up from 38% ten years ago. The continued growth in users, along with the valuable data that they generate, makes Meta and Google indispensable to not just users but also to advertisers. In view of all these factors mentioned, Big Tech companies are set to thrive and remain dominant in the years to come.
Valuations continue to remain attractive
Our confidence in the strong growth for the technology sector is bolstered by our assessment of the strong earnings growth momentum, seeing that the earnings recession for the technology sector is behind us. The ever-growing demand for generative AI applications would further benefit the sector, particularly Big Tech companies within areas such as cloud computing. Moving ahead, these companies would lead the next phase of growth in the sector, backed by their competitive advantages and sheer market dominance.
We think it is not too late to invest in the sector, as strong earnings growth has kept valuations attractive despite the strong rally (Figure 6). And as mentioned above, the recent pullback in share prices is also an opportunity for investors to take a position.
Figure 6: Valuations
continue to remain attractive
Based on our fair PE multiple of 30X, we arrive at a 2026 target price of USD 53 for the Invesco NASDAQ Internet ETF (NASDAQ: PNQI), representing an upside potential of about 37% (Table 1). As such, we maintain our 4.0 Stars “Very Attractive” rating for the sector. Apart from ETFs, investors who are keen to invest in technology sector via an active approach can also consider the Fidelity Global Technology A-ACC-USD Fund.
Table 1: Projections for NETX Index
|
Nasdaq CTA Internet Index |
2023 |
2024E |
2025E |
2026E |
|
PE Ratio (X) |
37.8 |
30.4 |
25.3 |
22.0 |
|
Projected Earnings Growth (YoY %) |
73.8% |
25.0% |
19.8% |
15.1% |
|
Projected Earnings Per Share (EPS) |
31.9 |
39.8 |
47.7 |
54.9 |
|
Target Fair Price (Based on a fair PE ratio of 30X) |
- |
- |
- |
53 |
|
Potential Upside (%) |
- |
- |
18.6% |
36.7% |
|
Source: Bloomberg Finance
L.P., iFAST Estimates |
||||
Figure 7: NETX Index Price vs EPS
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