Going in search of the UK's top technology stocks

– I should say up front that I got started on this article partly because of Carey’s great post about his tech-inspired fantasy fund – it’s an inspiring read! –

One of the biggest stories to come out of the US stock market over the past decade has been the spectacular rise of technology stocks. The relentless run in the Samp;P 500 has gone hand-in-hand with the growth of so many leviathan-like companies.  

Some of the best known names have been Facebook, Amazon, Apple, Netflix and Alphabet’s Google (the so-called FAANGs). Then there’s Microsoft, which is currently the biggest of the lot. Beyond them are dozens and dozens more multi-billion dollar tech groups. And while prices fell sharply across the sector last autumn, many have rebounded very quickly.

By contrast, UK quoted tech stocks have had nowhere near as much influence on the market here. To be fair, there have been some big wins. But successful tech has not been ubiquitous like it has in the States. So are UK investors missing out – or is the tech sector simply a different beast in the UK that still holds speculative upside for those who know where to look?

Inspiration from Silicon Valley

Right now, there are 88 stocks in the US technology sector that are valued at more than GBP £10 billion each. Twenty-four of them are valued at more than £50 billion and 11 at more than £100 billion. Microsoft, the most valuable of all, is valued at £665 billion (or around US $822 billion). That’s around $10 billion more than Apple – which is pretty much a rounding error when you get to this sort of size.

But while the big fish in US tech are genuinely huge, the pool of tech companies in the States is deep and wide. There are more than 830 companies classified in the sector, and while many are huge by most standards, hundreds more of them are small- and micro-cap plays. So the choice for investors is vast.

Alongside predominantly American companies are a few foreign names that have chosen the US as a destination to get quoted. You can count among them the likes of Alibaba, Baidu and Weibo from China. Then there’s Spotify from Sweden/Luxembourg, NXP Semiconductors and Yandex from the Netherlands, Trivago from Germany and Atlassian from Australia. This is not an exhaustive list, but you get the idea…

Tech opportunities in the UK

So while tech has been powering the US market in recent years, how do things stand in the UK? The answer is that homegrown tech giants are a bit thin on the ground.

Last year, a report by the private capital group GP Bullhound found that “multi-billion unicorns” were on the rise in Europe and that the UK was leading the way on this front – albeit with low single figures.

Part of the problem in the past, it seems, is that early stage funding has been a stumbling block for European firms. GP Bullhound points to stark differences in the numbers of “mega round” fundings (of more than £200 million) between the US and Europe. Again, it reckons that things are improving on this front.

Where tech firms look for capital

Interestingly, two potential new UK unicorns in recent years have actually opted for early public listings in order to access capital. One of them was On the Beach, an online holiday booking site that floated two and a half years ago. On the Beach had been partly owned by the private equity firm Inflexion before listing. But despite growing steadily, its valuation has dipped from close to a billion to just over half that today.

Another firm, Blue Prism, a robotics specialist, has done better. It’s is a rare case of a UK tech stock that’s earned itself a popular following despite no sign of a near-term profit. Chairman Jason Kingdon has said that public market investors were simply more receptive to the firm’s story than venture capital funds. As such, it’s managed to win over investors on the basis that it could have huge long-term potential. Blue Prism is currently valued at £1.22 billion.

As a side note — from an investment perspective there are interesting comparisons between Blue Prism and the retail technology group Ocado a couple of years ago. Back in 2017, Ocado was endeavouring to roll-out its technology but the market didn’t really understand it or where it was heading. As a result, Ocado became one of the most heavily shorted stocks in the market – but went on to re-rate dramatically when its tech deals started coming. If you see Ocado as a tech stock rather than a retailer (which is debatable), then it’s certainly now up there as one of the biggest quoted tech firms in the UK.

That aside, where do you go looking for tech opportunities in the UK market now?

Well, from a market cap perspective, here (in the table below) are the top five largest UK quoted stocks in the technology sector, together with a few key stats and ratings.

The Risk Rating spectrum is based on the 3-year standard deviation of each share, providing an idea of how volatile they are. The spectrum ranges from Highly Speculative, Speculative, Adventurous, Balanced and Conservative (these five are mid-range).

In terms of StockRank Style, High Flyers are denoted as high quality, strong momentum stocks, while Falling Stars are denoted as being high quality, weak momentum stocks.

As you can see, there have been some mixed price performances from the top five over the past year, with Aveva and Rightmove delivering positive gains. But Micro Focus, Sage and Just Eat actually underperformed the FTSE All-Share, which itself is down slightly over 12 months.

Sorting the sector by StockRank offers a different view. Opting for the best blends of Quality, Value and Momentum picks up much smaller stocks with slightly more speculative Risk Ratings. It’s a small sample but the EPS growth is higher in the smaller firms, which is what investors are likely to be looking at in riskier tech plays.

And in a nod to Carey’s post, here’s a Robbie Burns inspired tech screen that I’ve had to adapt slightly. This approach is a “growth as a reasonable price” strategy looking for below-average P/Es, growing earnings, low debt and positive momentum. That’s a tough call with tech stocks so I’ve adapted a few of Robbie’s standard rules (no minimum market cap, no maximum spread and no momentum restrictions). The results include some sharp decliners in the form of Gocompare and ULS Technology, but stocks like D4t4 Solutions and Scisys have held up better.

The future for UK tech investing

You could argue that technology stocks have represented a big part of the difference between market performance in the US and UK in recent years. While the American market has been driven by a huge tech sector and a handful of large, powerful stocks, the UK just hasn’t seen anything like the same.

But that doesn’t mean the future doesn’t hold some excitement for UK investors. Evidence suggests that the early stage funding environment is improving, and that may well feed through to more tech IPOs in the coming years. Meanwhile, despite the dearth of big names, there is still a considerable number of smaller cap technology stocks quoted on the market. Hidden amongst them could be some of the unicorns of tomorrow.

There’s a UK tech sector screen here that you can duplicate and make your own.

Stockopedia