European tech stocks are often overlooked in favour of what Wall Street has to offer. The Old Continent may not have tech companies on quite the same scale as the giants of the USA and China, but it does have some fantastic technology companies that are innovative, profitable and high growth. And they are far cheaper than comparable companies in the USA for no obvious reason other than they are not listed on a U.S. exchange.
The six U.S. stocks of the FAANG five (Facebook, Apple, Amazon, Netflix and Google/Alphabet) and Microsoft have between them accounted for a phenomenal 75% of the near 60% gain the S&P 500 has recorded since its March bottom. But their valuations now look riskily stretched. Across the tech-heavy Nasdaq, the average valuation is now 38 times projected earnings. That rises as high as times 80 for Netflix.
Opinions are split on whether U.S. tech stocks are in a second dotcom-style bubble or not. But even if you are happy to continue to invest in the U.S. tech sector, that doesn’t mean Europe may not also be worth a look. There are certainly some very solid tech businesses listed on European exchanges and, as mentioned, these high quality companies trade at far lower price to earnings ratios than equivalents across the pond.
So which are the hidden gems of the European tech sector?
Spotify may not be hugely profitable, finding it difficult to eke out a surplus, with a majority of revenues paid out to artists and record labels that have provided 300 million users access to more than 60 million songs. But it is a high growth company and a market leader in music streaming.
Spotify does also have competition from the music streaming offers from tech giants Apple and Google, among others. But it is doing well at maintaining market share and is internationally regarded as a better product than most competitors. Spotify is now available in 80 countries and some analysts believe the company could have 1 billion or more total users in 10 years.
Spotify is also now working hard to address the profitability question and is developing new revenue streams such as podcasts, which looks like both a scalable and profitable niche. Last year Spotify snapped up podcast companies Gimlet, Anchor and Parcast for a total of €357 million euros, which looks like good value. Something of a coup has been signing up Joe Rogan and his massively popular Joe Rogan Experience podcast, one of the most listened to in the world, on an exclusive multiyear deal.
Kim Kardashian has also been signed to an exclusive podcasting deal, as has the DC Comics universe. The Spotify share price is already up a spectacular 85% this year, having benefited from Covid-19 pandemic lockdowns. But some analysts feel the stock is still very much a ‘buy’, on the basis the full potential of the podcasting sector it is becoming a global market leader in, has not been recognised and priced in to the Spotify share price yet.
SAP has been around for a while, with the German corporate software solutions company founded in 1972 – earlier in the same decade as Microsoft and Apple. And like the American behemoths, SAP has stood the test of time, now worth an historical high of over $170 billion.
Like many tech companies around the world, SAP has also benefited from the Covid-19 pandemic as many of its corporate clients increased their reliance on the company’s products. Rearranging supply chains and generally digitalising more processes has been a feature of the pandemic and SAP’s revenues have soared.
The SAP share price has gained over 30% in the past 3 months alone, and is up around 120% over the past 5 years. But its growth rates, compared to revenues and profits, are nothing compared to that of comparable companies in the USA, indicating that there could still be plenty of mileage left yet in SAP stock.
The Swedish telecoms company has had its ups and downs over the years but has now refocused on providing the technology for 5G networks. The company’s management is supremely confident the move to upgrade telecoms networks to 5G will drive Ericsson’s growth over the next few years.
The political backlash against China, especially the growing tensions between the USA and China, is proving damaging to Huawei, Ericsson’s Chinese rival in 5G technology and Ericsson is perfectly positioned to be one of the main beneficiaries. The UK government, for one, is likely to turn to Ericsson for at least part of the technology that would have been provided by Huawei before the decision to cut the Chinese company out of critical infrastructure.
British accountancy and payroll software company Sage, whose products are used by small to medium sized accountancy firms and companies for their own inhouse accounting and payroll, is the global leader in its sector. Profitable, generating plenty of cash and with a strong balance sheet, Sage’s roughly x25 value to earnings ratio looks like very good value in the context of global tech valuations.
The company continues to innovate and has future-proofed its software through significant investment in cloud-based services. Sage’s customer base has grown considerably in recent years and it has shown resilience throughout the coronavirus crisis downturn. The company also pays a dividend, which looks more than sustainable, covered comfortably by cashflow and profits.
Another UK-based software company, Aveva will overtake Sage as the country’s biggest when its agreed $5 billion acquisition of U.S. company Osisoft goes through. The deal is expected to take Aveva’s market capitalisation above $10 billion.
Aveva specialises in software that helps companies design industrial machinery. Osisoft produces software that helps companies including Heineken collect and analyse data coming out of their production facilities, in real time.
The company is very well placed to benefit from the increasing role of connected devices and data as the manufacturing sector finally begins a true digital transformation, having remained one of the last major industries to do so.
German IT services company S&T, listed on the Nasdaq Europe, has also been a major beneficiary of the Covid-19 pandemic and reported its 46th consecutive profitable quarter over the three months to the end of June.
The company, which has IT outsourcing bases in Bulgaria, Slovakia and Ukraine, and services mainly West European client base of major corporations, trades on a relatively modest 31 times earnings. That looks good value against a backdrop of steadily growing sales, earnings and operating cash flow.
Dutch company ASML provides the global semiconductor industry with crucial photolithography equipment. It is currently the only country in the world able to offer the kind of EUV (extreme ultraviolet light) necessary to concentrate the number of transistors needed to produce the faster chips the technology industry now requires. That gives the company a monopoly that has led to extremely profitable margins at a time when the semiconductor industry continues to grow at pace.
Again, with the Covid-19 pandemic accelerating the move online, more data centres, computers and online systems are needed than ever before, as are more powerful chips for machine learning AI. The future looks bright for ASML.