Four top tech stocks to buy in a dip

Despite the inevitable pullback in September, tech (information technology) remains the best performing sector this year on the ASX and on most global exchanges. In Australia, it is up 22.4%, while in the USA, the sector has returned 24.5%.

There are good reasons why tech has performed so well and should continue to do so. Firstly, it is one of the few sectors where there is genuine growth – that is, companies are growing earnings because consumers and businesses are spending more. Secondly, the COVID-19 pandemic has accelerated tech dependent changes in the way we consume – online shopping, cashless payments, cloud computing, work from home, demand for personal gadgets, home entertainment etc. While these trends were in place before Covid, they have been given added impetus by the pandemic, and growth in demand that might have taken several years to achieve, has been crunched into a few months. Finally, the major tech companies boast extraordinarily strong balance sheets and are spinning off cash.

The question, as always, is the price. There is no doubt that the market got way ahead of itself and tech stocks rallied too hard. That is normal behaviour for markets – they go too far up and down. However, the trend remains in place and as the reasons are still valid, dips are a buying opportunity.

Here are 4 top tech stocks to consider buying in the dip. Two are local and two are overseas, but that fact shouldn’t rule them out. Arguably, they are too big not to be in your portfolio and investing overseas really is quite easy.

1. Xero (ASX: XRO)

A New Zealand company by origin, Xero is the leader in cloud accounting software in Australasia. Talk to any small business owner or their accountant, the chances are that they will sing the praises of Xero. It went to the cloud first and left established competitors, including MYOB and global player Intuit (QuickBooks), in their wake. With 914,000 subscribers in Australia (up 26% on the previous year), it is now the largest player.

It has been expanding offshore, with 613,000 subscribers in the UK and 241,000 in North America. Overall, it grew subscribers in FY20 by 467,000 to 2.285m.

In the year to 31 March 2020, revenue grew by 30% (29% in constant currency) to NZ$718.2m, ARPU (average revenue per user per month) was up 2% to NZ$29.93 and EBITDA was NZ$64.6m higher at NZ$137.7m. Somewhat surprisingly for an IT “high flyer”, Xero actually made a profit, recording a maiden contribution NZ$4.8m.

The things I like about Xero are that its core product, accounting software, is incredibly sticky – typically accountants (and their clients) do not like change, and churn is relatively low.  It is cloud based which makes the business very scalable. You might be forgiven for thinking that this wouldn’t be much of a competitive advantage in 2020, yet remarkably, 80% of the accounting software in English speaking markets outside Australasia doesn’t sit in the cloud.

Finally, Xero has a great history of innovation and it is using this to drive its small business platform. This is the provision of services in addition to accounting such as bill paying, e-invoicing, access to capital, data leveraging applications etc. Ultimately, Xero is trying to build an eco-system around the accounting software that allows it to grow ARPU.

Xero (XRO): Last 12 months

Source: Nabtrade

The question then for investors is “the price”, and on that front guidance from the broker analysts is relevant. Their consensus target price is $81.17, 16.9% below Friday’s close of $9.63. Range is low of $60 from Ord Minnett to a high of $100 from Morgan Stanley.

2. NEXTDC (NXT)

NEXTDC (ASX: NXT) is involved in the development and operation of independent tier III and tier IV data centres in Australia. It focuses on providing scalable, on-demand services to support outsourced data centre infrastructure and cloud connectivity for enterprises of all sizes.

It grew data centre services revenue by 18% in FY20 to $200.8m, and over the last 6 years, revenue has grown at a CAGR (compound annual growth rate) of 28%. Underlying EBITDA grew by 23% in FY20 to $104.6m.

NEXTDC has been improving operating metrics (revenue per square metre and revenue per unit of power consumed). It is well capitalised for growth, with additional data centres in Sydney, Melbourne and Perth under development. For FY21, it has guided to revenue of $242m to 250m (growth of 21% to 25% on FY20), and underlying EBITDA of $125m to $130m (up 20% to 24% on FY20).

NEXTDC (NXT): Last 12 months

Source: Nabtrade

The major brokers are positive on the stock (6 buy recommendations, 1 neutral recommendation). According to FNArena, the consensus target price is $12.67 (about 1.4% higher than Friday’s close of $12.46). The range is a low of $10.25 from Citi to a high of $14.15 from UBS.

3. Apple Inc (NASDAQ: AAPL)

The second largest company in the world by market capitalisation (Saudi Aramco is the biggest), Apple shares have already pulled back by around 19% from their peak on 2 September of US$137.98. Admittedly, the peak was somewhat artificial, driven by a surge relating to a stock split – one share became 4 new shares, and high expectations about a forthcoming product launch.

Now trading around US$112, it has been quite a pullback. Even so, the shares are still up 27% over the last 3 months, 52.9% this calendar year and 104% over the last 12 months. So on these numbers alone, it seems right to be cautious.

Apple (APPL): Last 12 months

Source: Nabtrade

Apple grew product revenue by 10% and services revenue by 15% in the third quarter (ending 30 June), to report an EPS (earnings per share) of 65c for the quarter. This beat analysts’ expectations by 25.6% and was up 18.3% on the corresponding quarter in FY19. For the current and final quarter for FY20, which ends on 30 September, analysts are forecasting EPS to increase to 71c per share.

Earnings per share of $3.24 per share for FY20 puts Apple on a high, but not overly demanding price earnings (PE) multiple of 34.6 times. Looking ahead to FY21, the analysts have Apple trading on a multiple of 29.2 times forecast earnings.

According to CNN Business, of the 40 investment analysts who follow the stock, 23 have buy recommendations, 13 have hold and 4 have sell recommendations. The median consensus 12-month price target is US$125, with a low of US$80 per share and a high of US$160.

Apple has almost US$200bn in cash and marketable securities, partially offset by US101bn in term debt. Operating activities alone generated about US$60bn in cash for the nine months to 30 June, most of which was applied to an ongoing stock buyback programme.

4. Microsoft (NASDAQ: MSFT)

Currently the third biggest company by market capitalization, Microsoft operates through three business segments: Productivity and Business Processes; Intelligent Cloud; and More Personal Computing. The Productivity and Business Processes segment comprises products and services such as Microsoft Office, LinkedIn and Microsoft Dynamics, The Intelligent Cloud segment includes server products and cloud services (Azure); and The More Personal Computing segment encompasses products and services geared towards the interests of end users, developers, and IT professionals such as Windows, Surface and Xbox.

In the fourth quarter of FY20 (Microsoft’s balance date is 30 June), revenue grew by 13% to $38bn and operating income by 8% to $13.4bn. Earnings per share of US$1.46 beat the analysts’ forecast of $1.34. For the full year, revenue grew by 14% to US$143.0bn and operating income by 23% to $53.0bn. Full year EPS was $5.76 per share. All segments performed strongly, with Intelligent Cloud being the star with revenue growth of 24%.

Microsoft (MSFT) – Last 12 months

Source: Nabtrade

Of the 31 investment analysts who follow the stock, 28 have buy recommendations, 3 have hold and there are 0 sell recommendations. The median consensus 12 month price target is US$233, with a low of US$208 per share and a high of US$260.

Microsoft will report its first quarter earnings for FY21 on October 22. The analysts expect earnings per share of $1.54 and sales of $35.8bn. For FY21, analyst forecast earnings of $6.46 per share, placing Microsoft on a forecast multiple of 32.2 times. For FY22, the forecast is 28.3 times.