Everything you need to know about investing in technology

The ASX information technology sector includes everything from major companies everyone knows to big and small players operating primarily behind the scenes. The tech sector is also home to start-ups, emerging companies of all sizes, and billion-dollar household brands.

In a broad sense, the ASX technology sector comprises companies involved in researching, creating, and distributing technology-based goods or services. That's everything from computers to software and televisions to websites. 

Hardware is a physical technology device, such as a computer, television, or smartphone. Software is the computer codes, programs, and platforms that make those physical devices work.

About ASX technology shares

The growth-oriented tech space offers investors plenty of opportunities. Despite the economic uncertainty caused by higher interest rates and runaway inflation, many ASX technology shares have significantly outperformed the rest of the market over the past 12 months. 

Not only that, but the sector has also comfortably outperformed (including dividend returns) the S&P/ASX 200 Index (ASX: XJO) over the past five years on average (as of 18 June 2023), as you can see in this table below:

In fact, the tech sector has outperformed almost every other market sector over the past five years, including healthcare. These solid historical returns, however, do not mean the technology sector is without risks. 

Technology changes rapidly, and one-time leaders can quickly fall behind or go out of business. Remember Kodak? Remember Blockbuster Video? Once at the forefront within their industries, these companies have been brutally supplanted and made redundant by technological change.

Promising emerging companies also may make a considerable splash initially, only to fade out quickly.

Technology is an exciting space that encompasses many trends. Social media, artificial intelligence (AI), smartphones, blockchain, self-driving technologies, software as a service (SaaS), the Internet of Things (IoT), streaming media services, and more. It's an area full of innovation and opportunity but also some risk.

Tech can be volatile 

On the ASX, the tech sector is best represented by the S&P/ASX All Technology Index (ASX: XTX). This index tracks the information technology sector, consumer electronics, interactive media and services, and healthcare technology. 

Many tech stocks are considered high-risk, high-reward investments. By their very nature, tech stocks operate at the cutting edge of their fields. They develop radically new products and services. In the drive to become profitable, they typically invest heavily in research and development in the early years. 

This is great in a bull market when interest rates are low, investors feel optimistic, and consumer confidence is high. In an environment like this, growth shares (like many in the tech sector) will often outperform the broader market. But things can quickly change. 

And when the market gets bearish, tech shares are often amongst those worst hit.

The COVID-19 pandemic provides an excellent recent example of this. As we all know, 2020 was defined by one of the most volatile periods in global stock market history due to a black swan event that led to a short but extremely sharp bear market. 

In the throes of the COVID-19 crash, tech shares were hammered far harder than the broader market. This was primarily due to the relatively expensive nature of the sector for investors relying on traditional methods of stock evaluation, such as the price-to-earnings (P/E) ratio. 

Boom and bust

In times of panic, many investors flock to safety and move their investments to large-cap shares with long-standing track records for delivering profits. 

Technology companies also skew younger than average, and many are yet to make a profit. This makes them susceptible to large share price falls, especially in unprecedented times or when investors feel nervous. 

However, such falls can be reversed extremely quickly. Looking back immediately after the market sell-off bottomed in March 2020, we saw a steep recovery for tech stocks. The ASX All Technology Index gained a massive 39% gain in just six months. 

All this is to say that the technology sector can boom and bust. Price bubbles can develop, then burst and lead to rapid price corrections. It is a fast-evolving industry with advancements made in short timeframes. This can make some companies incredibly wealthy while rendering others obsolete. 

As investors, we hope that we only pick the winners. But we also need to remember that it's very likely some of our tech investments will fail. It's just the nature of the industry. And preparing yourself for that possibility is part of any good risk management strategy.

Areas for investment 

Technology is a wide-ranging term. It has expanded far beyond what once would have been considered the typical tech shares, like Apple Inc (NASDAQ: AAPL) or Microsoft Corporation (NASDAQ: MSFT).

Tech companies operate in various market segments that are all part of the broader technology sector. They include:

AI, payments, blockchain, self-driving tech, computers and software

Artificial intelligence (AI): This is where computers perform tasks that traditionally have required a human brain. AI also encompasses deep learning and machine learning. Deep learning involves scientists building computer models using data inspired by the human brain's structure and function that reproduces our learning ability. Machine learning, by contrast, is a type of AI where computers learn without being specifically programmed to do so. You're probably familiar with AI systems like Siri from Apple or Alexa from Amazon.com Inc (NASDAQ: AMZN). But you might not be aware that systems like these are driven by the valuable data that ASX company Appen Ltd (ASX: APX) provides.

Payments: The area of payments has attracted substantial innovation over the past decade. As cash and cheques become increasingly unpopular, many ASX companies have tried to make their mark on a future without cash. Buy now, pay later (BNPL) pioneer Afterpay was the most well-known ASX company in this space before US payments giant Block Inc (ASX: SQ2) acquired it in 2022. Other ASX BNPL providers include Zip Co Ltd (ASX: ZIP) and Splitit Ltd (ASX: SPT).

Blockchain: This has received much publicity because blockchain is the technology behind Bitcoin (CRYPTO: BTC) and other virtual currencies. Many investors scorned it following the 'Bitcoin bubble' of 2017. However, blockchain has many other potential applications. The concept of a blockchain 'ledger' – a single, decentralised, and incorruptible transactional record – might be of enormous value in the future. 

Perhaps it's no surprise that we continue to see Bitcoin and other cryptocurrencies regain favour with investors more recently, despite their trademark volatility.

Self-driving technologies: This is not an area in which many ASX companies specialise. But US companies like Alphabet Inc (NASDAQ: GOOGL) and its subsidiary Waymo, Tesla Inc (NASDAQ: TSLA), Uber Technologies Inc (NYSE: UBER), and most major car manufacturers are working on creating self-driving cars. Some driver-assist technology has already come onto the market, and it's possible that self-driving cabs, and even trucks, will be in limited use reasonably soon.

Computers and software: These companies make laptops, desktops, tablets and the software that runs them. This segment also includes component players but is dominated by US giants like Intel Corporation (NASDAQ: INTC), which makes the chips and processors that power computers, along with bigger, well-known brands such as Apple and Microsoft. Xero Limited (ASX: XRO) is a nice contrast. It is a software company that markets its cloud-based accounting solutions in a Software-as-a-Service (SaaS) subscription model.

Internet, streaming media, cloud computing, cybersecurity

The Internet: Typically, you might think of US companies like Alphabet's Google, Amazon, eBay Inc (NASDAQ: EBAY), and Meta Platforms Inc (NASDAQ: FB) if someone mentioned 'internet companies'. But the ASX has a few shining stars, including Carsales.com Ltd (ASX: CAR) and REA Group Limited (ASX: REA). Most of these players are at least partially supported by advertising revenue, though some sell subscriptions and monetise in other ways.

The Internet of Things (IoT): The IoT is the network of devices connected to each other and 'the cloud' – the public internet that allows for links between far-flung systems. 

It is involved in everything from a smart thermostat that can automatically adjust the temperature in your home to complex medical equipment that can order its own repairs. The agricultural industry is also benefitting from the rise of IoT. 'Smart sensors' are being used to detect soil conditions, and automated machinery can treat crops based on those soil conditions. Altium Limited (ASX: ALU) is the ASX share that may benefit most from the IoT. Altium makes software that assists in designing and manufacturing electronic circuit boards, which are components required in every internet-enabled electronic device.

Streaming media: The first name that might come to mind is US behemoth Netflix Inc (NASDAQ: NFLX), perhaps followed by Amazon Prime or, more recently, Disney+ from Walt Disney Co (NYSE: DIS).

Here in Australia, we have our homegrown streaming service Stan, owned by Nine Entertainment Co Holdings Ltd (ASX: NEC). Stan and its American compatriots are entertainment and technology companies that have created their own digital infrastructure. Stan purchases and creates content for its streaming platform and also develops and maintains the digital platform.

Cloud computing: 'The cloud' is a familiar term for computerised storage infrastructure that allows devices to access information and services from anywhere. The cloud enables companies (and individuals) to use services not resident in their devices. NextDC Ltd (ASX: NXT) and Megaport Ltd (ASX: MP1) are major ASX cloud service companies.

Cybersecurity: Cybersecurity is about ensuring information is only accessible to those who are supposed to see it. Keeping information secure has become a growing industry, with data now housed in the cloud, on our devices, and even in the chips on our credit cards. The ASX is home to some small cybersecurity players and a cybersecurity-themed exchange-traded fund (ETF) with an unforgettable ticker available – the BetaShares Global Cybersecurity ETF (ASX: HACK). More on ETFs later.

Technology is everywhere 

You can invest in technology without buying a pure information technology sector stock. Technology has bled into nearly all areas of life, so many non-tech companies have morphed into partial-tech shares because so many are using technology to grow. 

For example, Coles Group Ltd (ASX: COL) has a huge retail shopfront presence in Australia but also invests billions into supply chain automation and logistical technology. The supermarket giant uses innovation to lower costs and increase responsiveness to customer needs.

ASX blue-chip stalwart Commonwealth Bank of Australia (ASX: CBA) has moved into the payments space with its Klarna partnership.

Domino's Pizza Enterprises Ltd (ASX: DMP) is trialling drone technology to deliver pizzas to its customers faster and more cheaply.

A look at technology ETFs 

An ETF is a fund that invests in multiple shares but is sold like a single share on the ASX. 

Most ETFs track a specific index, so they provide a way to own an entire market sector without purchasing every stock individually. For example, you might buy an ETF comprising all 200 shares in the ASX 200 or a smaller ETF tracking biotech companies.

Like a mutual fund, an ETF has an expense ratio – the percentage of the fund's assets used to cover management, advertising, and administrative fees. In a broad sense, lower is better, but you should look at overall returns, not just the expense ratio, when considering an ETF.

There are several tech ETFs available on the ASX. We've already discussed HACK, but other examples include the Morningstar Global Technology ETF (ASX: TECH), which tracks a global basket of large-cap tech shares such as Netflix and Alphabet. 

The BetaShares S&P/ASX Australian Technology ETF (ASX: ATEC) tracks every share in the ASX All Technology Index. The Robo Global Robotics and Automation ETF (ASX: ROBO) follows a basket of AI and robotics-focused companies. 

There are plenty of choices out there!

Which metrics matter most? 

Technology companies typically fall into two baskets – developing brands and mature companies. 

Mature companies like Nine Entertainment or REA Group still have to innovate to survive in the long term, but they have a base of products that have become entrenched in the market. This provides long-term revenue stability, allowing them to develop their products without worrying about how to keep the lights on.

REA Group, for example, has leveraged the vast amount of property data collected from its customer base to expand into property valuation and mortgage broking. A mature technology company is valued partly through traditional methods, including profit, revenue growth, and overall sales. Of course, because technology is an ever-changing space, even a company like REA can see its share price rise or fall based on an unproven product or even an announcement of new development.

Developing brands, such as Zip, face a different challenge. These are companies valued mainly on their sales growth and future potential, not current profit. That could be why we've seen a collapse in the value of BNPL companies like Zip over the past 12 months – falling consumer confidence, high inflation and rising interest rates (not to mention ongoing regulatory uncertainties) make it more difficult for investors to put a valuation on Zip's future.

As such, developing brands generally have more upside (at least at first), but they come with significant risk.

Who should invest in technology? 

Technology shares offer opportunities for novice and experienced investors alike. They are a highly diverse collection of companies operating in many different fields. And the sector includes many household brands that have become a part of our daily lives, like Afterpay, Apple and Netflix.

It's also an investment space where the average person can jump on an emerging technology they have experienced and believe will become part of the future.

Technology shares offer opportunities for both growth and income investors, who can choose from several mature, established companies. Of course, this is a rapidly developing sector, so there are usually some growth prospects, even in mature companies.

Trying to get a clear picture of the value of a technology share can be difficult. The products and revenue streams can be more complex than a consumer goods company like Woolworths Group Ltd (ASX: WOW), which sells brands and products most of us are familiar with. 

Valuing tech stocks can also be complex. We can value companies using several methods, including earnings-based, revenue-based, cash flow-based, equity-based, and member-based valuations.

Growth investors might like … 

Buying shares in companies expected to grow a lot in the future is known as growth investing. You often pay a premium, but these shares are valued on what the company might achieve in the future rather than what it has achieved so far. Growth stocks often receive a great deal of analyst attention, sometimes belying the actual size of the company.

Of course, buying in early on a growth stock can bring tremendous returns. An outstanding case study in recent history is Afterpay, which priced its initial public offering (IPO) at $1 in May 2016. It was a volatile investment ride (to say the least), but by February 2021, Afterpay shares peaked at just over $160, making this company a '160-bagger' in just five years. Afterpay was acquired by Block for $39 billion in Australia's biggest-ever corporate deal in 2022.  

Another interesting case study is Xero. This company has been listed on the ASX since 2012 and has been in full 'growth' mode ever since. It wasn't until 2019 that it started to turn a profit. 

Between 2012 and December 2021, the Xero share price rose from about $4.50 to an all-time high of $157.99 (it currently trades at a bit under $120 a share). The fact that investors were willing to assign a P/E ratio above 500 to Xero shows their faith in the company's growth runway, despite its delayed profitability.

This is why you should look at both valuation and market potential when deciding whether to invest in one of these companies. There's no single way to do this, but consider forward earnings projections, the earnings growth rate for calculating the forward P/E ratio, and the price-to-earnings-to-growth (PEG) ratio. 

For growth companies, pay attention to free cash flow and debt to better understand the business's overall financial health.

Dividend investors might like … 

The tech sector in Australia is not well known for its dividend strength. We have more developing brands and fewer established mature tech companies. It makes more sense for younger technology companies to invest free cash in research and development instead of distributing dividends.

Over in the US, established tech companies like Apple and Microsoft have started paying healthy annual dividends to their investors. Still, there are exceptions. ASX stock market services provider Computershare Limited (ASX: CPU) was founded in 1978 and listed on the ASX in 1994. It began paying dividends in 2019, and in 2023 it is offering an annual dividend yield of about 1.8%.

Top ASX technology shares

Tech stocks often straddle a couple of market sectors. Many ASX Information Technology sector companies combine technology with other services. For example, Xero is also a services company, and Zip Co is also a financial or payments company.  

Investors can gain exposure to various industries by investing in tech stocks. Maybe you don't think BNPL stocks have a bright future, but you believe demand for cybersecurity services will skyrocket in future. You can still gain that exposure by investing in technology stocks and ETFs. 

Three of the largest ASX technology stocks by market capitalisation include:

WiseTech

All the companies on this list are members of what used to be the ASX tech scene's hottest club – the WAAAXers. Along with Appen, Altium, Afterpay, and Xero, the WAAAX shares were described as Australia's answer to the US FAANG group, consisting of Facebook (now Meta Platforms), Apple, Amazon, Netflix, and Google (whose parent company is Alphabet).

WiseTech is a logistics specialist. Its flagship software CargoWise is an 'all solution' platform that assists global logistics operations such as customs and trade. The company has grown quickly in recent years by pursuing an aggressive mergers and acquisitions (M&As) strategy, although it has come under attack from short-sellers on several occasions.

Xero 

Next up is tech stock Xero, another SaaS giant of the ASX, which offers online accounting software services to small and medium-sized businesses.

Xero was born after founder Rod Drury noticed how difficult it was for small businesses to do their books – and how much of a dreaded task this was for owners. Xero is a New Zealand company, listed in Auckland in 2007 and on the ASX in 2012. Since then, the company has become an ASX tech heavyweight.

Xero has a seemingly endless runway in front of it. Many countries are even pushing to make it mandatory for businesses to manage their bookkeeping and tax obligations through online channels like Xero.

NextDC

NextDC is an Australian data centre operator. Data centres are facilities that house computer hardware, telecommunications equipment, storage systems and other IT infrastructure and computer equipment.

As computer systems have become increasingly complex, the importance of data centres has increased. Data centres can help securely store data, protecting sensitive information from hackers. They also have backup generators and other fail safes to ensure that corporations and other institutions can continue to operate in a power outage or natural disaster. 

NextDC is the leading data centre operator in the country. It owns facilities across Australia and has several international centres in the planning and development phases in New Zealand, Japan and Malaysia.