Regulatory, valuation risks coming to tech stocks

Investing in tech can provide investors with pulse-racing highs, but also stomach-churning lows if price surges are fuelled by too much speculative interest and too little revenue.

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The chances of a tech bubble like the one at the turn of the millennium are low, says Jonathan Mzengeza, portfolio manager for technology at CIBC Asset Management. Many tech companies perceived as expensive are different from those of the dot-com era, he says.

“A lot of them are generating revenue [and] are at least cash-flow break-even or even generating positive free cash flow,” Mzengeza said in a Dec. 16 interview.

Further, he noted that many tech companies have “very large” growth opportunities.

“If you look at the current market share of these companies versus the total addressable market, it’s pretty low,” said Mzengeza, who manages the CIBC Global Technology Fund and the Renaissance Global Science and Technology Fund.

But even if a bubble is unlikely, risks in the tech sector remain.

For instance, there’s policy risk, which Mzengeza assesses using his firm’s environmental, social and governance framework. “Social is probably one of the biggest risk components” within tech, he said.

As such, he evaluates which companies have a known or perceived high market share in regions ready to impose regulation. These include social media and internet companies in the U.S. and Europe.

Regulatory pressure impacts a company’s revenue and growth structure, he said, as the company is forced to spend money to meet regulatory demands instead of on innovating.

Among these companies, Facebook likely has the highest regulatory risk, given its “perceived dominance” in social media, he said. As a result, “We’ve reduced our exposure.”

Google is another name with regulatory risk, Mzengeza said. Amazon, however, carries less risk given its low share in many of the markets in which it competes.

Finally, valuation continues to be one of the greatest risks.

While many tech companies have growth opportunities ahead, the question is: What do you pay for them?

Mzengeza said he uses a “rigorous” valuation framework using long-term discounted cash flow and scenario analysis, the latter of which helps indicate potential upside or downside.

“We look to invest in companies that have greater upside opportunity,” he said. “A company may look  overvalued, but the downside and upside opportunity may skew to it being not as overvalued as people may perceive.”

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