Our top picks for the technology sector are Adobe, Fortinet, and STMicroelectronics.
After a strong 2023, tech continued to perform well in the second quarter of 2024. Even as semiconductor companies remain pressured from a results standpoint, software and services generally reported solid results. However, software stocks have pulled back as the Fed disappointed investors with no interest rate cuts thus far in 2024. On the flip side, semiconductor stocks have performed well. We see no consistent performance differentiation among market capitalization tranches. We remain confident in secular tailwinds in the sector, such as cloud computing, artificial intelligence, and the long-term expansion of semiconductor demand. Still, after a strong run for technology stocks since the beginning of 2023, we see pockets of opportunities.
The most important force we see across technology revolves around generative artificial intelligence. Software companies are developing and incorporating next-generation AI capabilities into their solutions, cloud providers are introducing new services and ramping capacity, and semiconductor firms, notably Nvidia NVDA, are experiencing surging demand for AI and data center chip applications.
The US Technology Index is up 41% on a trailing 12-month basis, compared with the US equity market being up 26%. Over the past quarter, the US equity market was up 1%, while tech was up 6%.
While the median US technology stock is fairly valued, the overall tech sector trades at a 10% premium, as the high valuations on several mega-cap tech stocks skew the overall sector’s valuation. We see semis and hardware as the most overvalued, with software skewing toward undervalued.
Investors are excited about generative AI and have been searching for stocks within this theme. We think there are opportunities beyond Microsoft MSFT and Nvidia, and we expect networking investment in generative AI to grow in line with investment in GPUs, representing a derivative investment avenue. We view this opportunity as durable and long-lasting, even if we see most of the best-positioned networking stocks as fairly valued or overvalued today.
Adobe ADBE has come to dominate content creation software with its iconic Photoshop and Illustrator solutions, both of which are contained in the broader Creative Cloud, which is the clear leader for software for creative professionals. Adobe Express is widening the funnel for new customers, which we think bodes well for growth over the next several years. We also see Firefly generative AI models as an important growth driver. Overall, we see plenty of momentum within product innovation, client interest, and revenue creation, and we are encouraged by strong second-quarter results after a slight hiccup on the March earnings call. We continue to see valuation as attractive.
We expect a modest recovery in firewall spending in the back half of 2024, which should quell some apocalyptic concerns about firewall spending. We also think investors are overly pessimistic about Fortinet’s FTNT newer security forays into SecOps and SASE, where we believe the firm’s expansion will continue to bear fruit, with a greater portion of sales/billings being driven by these new verticals. So far, the firm’s recent investments in SASE and SecOps are tracking along nicely and allowing for upsell from the firewall-installed base. We also think Fortinet will benefit from the trend toward vendor consolidation over the next several years. Shares are attractive, in our view.
STMicroelectronics STM is one of our top picks in the sector, as our fair value estimates of $60 offer an attractive margin of safety for long-term, patient investors. We continue to like the long-term secular tailwinds in the automotive end market, as ST should profit from increased chip content per car, especially in electric vehicles. The company has also achieved nice gross margin expansion in recent years, and we foresee it maintaining these margins in the long run.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.
Dan Romanoff, CPA, is a senior equity research analyst on the technology, media, and telecommunications team for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. He covers software.
Before Joining Morningstar in 2019, Romanoff spent 12 years in buy-side equity research covering the technology and telecommunications sectors, most recently at Holland Capital Management. Prior to that, he spent five years in sell-side equity research as an associate analyst at UBS and a senior analyst at Credit Suisse covering various areas within technology, including hardware, software, and semiconductors. Romanoff also has worked as an auditor and in valuation services for major public accounting firms.
Romanoff holds a bachelor’s degree in accountancy and a Master of Business Administration in finance, both from the University of Illinois at Urbana-Champaign. He also holds the Certified Public Accountant and Accredited in Business Valuation designations.
Transparency is how we protect the integrity of our work and keep empowering investors to achieve their goals and dreams. And we have unwavering standards for how we keep that integrity intact, from our research and data to our policies on content and your personal data.
We’d like to share more about how we work and what drives our day-to-day business.
We sell different types of products and services to both investment professionals and individual investors. These products and services are usually sold through license agreements or subscriptions. Our investment management business generates asset-based fees, which are calculated as a percentage of assets under management. We also sell both admissions and sponsorship packages for our investment conferences and advertising on our websites and newsletters.
How we use your information depends on the product and service that you use and your relationship with us. We may use it to:
To learn more about how we handle and protect your data, visit our privacy center.
Maintaining independence and editorial freedom is essential to our mission of empowering investor success. We provide a platform for our authors to report on investments fairly, accurately, and from the investor’s point of view. We also respect individual opinions––they represent the unvarnished thinking of our people and exacting analysis of our research processes. Our authors can publish views that we may or may not agree with, but they show their work, distinguish facts from opinions, and make sure their analysis is clear and in no way misleading or deceptive.
To further protect the integrity of our editorial content, we keep a strict separation between our sales teams and authors to remove any pressure or influence on our analyses and research.
Read our editorial policy to learn more about our process.
© Copyright 2024 Morningstar, Inc. All rights reserved. Dow Jones Industrial Average, S&P 500, Nasdaq, and Morningstar Index (Market Barometer) quotes are real-time.
