It's no secret Canadian investors' love affair with resource stocks has come to an abrupt end this year. With the price of gold plummeting and the energy sector languishing, where are investors to turn for stocks with high growth potential?
The answer may be tech. Yes, technology stocks. Many investors may have bad memories of the 2000 tech stock bust – including the sorry tale of Nortel Networks Corp. More recently there has been the white-knuckle roller-coaster ride of BlackBerry Ltd.
But the truth is the technology sector has quietly been one of the strongest parts of the Canadian market in the past 12 months.
Since last July, the S&P/TSX Information Technology index has been the second-best performer among the 10 index groups. The tech index is comprised of the seven largest companies in the sector – when you look beyond the big names, the performance is even more impressive.
Toronto brokerage house M Partners has been tracking 30 of the small-cap tech stocks listed on the TSX and TSX Venture Exchange. Over the past three years, the RES30 Small Cap Tech Index has enjoyed annual returns of 28 per cent, 25 per cent and 38 per cent.
"The Canadian technology sector is vibrant and full of excellent companies," says Robert Young, a technology sector analyst at investment bank Canaccord Genuity. He says it's "unfortunate" that high-tech companies account for a small component of Canada's public markets, stemming from a slow pipeline for private tech companies going public, as well as a large number of Canadian companies being bought by foreign entities.
"Investors are certainly looking deeper at technology stocks than they were a year ago," Mr. Young says. He goes so far as to say that risk capital in this country has been inefficiently allocated to mining and resource stocks – and with weakness in those sectors, there may be renewed demand for technology securities.
Ron Shuttleworth, a senior technology analyst at investment bank M Partners, also sees a move toward tech.
"There is a general sector rotation among Canadian institutions away from mining and other resources, and into sectors such as real estate, financials and technology."
Mr. Shuttleworth says since the tech sector is smaller than others, investors moving into the space are having trouble finding stocks, and that has helped fuel gains in equity value – as well as sparking interest in new listings.
There have been some tremendously successful tech initial public offerings in the past year or so. Avigilon Corp. went public late in 2011, and its shares have more than quadrupled in value. Just last month Halogen Software Inc. hit the market – its share issue was oversubscribed, and it has traded above its issue price ever since.
"There is a significant latent demand for more listings – expect a lineup of IPOs [initial public offerings] over the next several quarters," Mr. Shuttleworth says.
Mr. Young adds that there are plenty of excellent private technology companies that may decide to go public – he names firms such as D-Wave Systems Inc., Dejero, Desire2Learn and Shopify.
While there are likely to be opportunities in the IPO market, there are companies already trading that are finding favour.
Mr. Young's current top picks are WiLAN and Com Dev International Ltd. WiLAN is an intellectual property licensing company based in Ottawa. It acquires technology patents, and then licenses those patents to some of the industry's biggest companies.
"I like WiLAN because it has a large licensing backlog. If you add that to the company's large cash balance and the value of its patent portfolio, the current price ignores much of the potential future growth." He also likes the company's dividend payout – a rarity in this sector.
Com Dev is a designer and manufacturer of what the company calls "space hardware" – mainly satellites and related systems. Mr. Young says he likes Com Dev because of the strong bookings it has reported in the past several quarters, as well as the upside potential of a growing data business called exactEarth in which it owns a majority stake.
Com Dev has also caught the attention of James Hodgins, chief investment officer of the Curvature Market Neutral hedge fund. He also cites the company's recent "strong revenue growth," as well as its positioning in the flourishing field of satellite communications.
Mr. Hodgins likes to include new media in his definition of the technology sector, and as such considers DHX Media Ltd. as his top pick. DHX is the top independent producer and distributor of children's content globally. Mr. Hodgins says the company is capitalizing on the fast-growing distribution of new digital media distribution channels. He believes DHX's unique and large library makes it a top takeover candidate.
Mr. Shuttleworth says his group at M Partners is focusing mostly on business software firms, with an emphasis on mobile infrastructure. Their top picks are Descartes Systems Group Inc., Solium Capital Inc., Redknee Solutions Inc. and Mitel Networks Corp.
There are some other factors that could give the sector an additional lift. Mr. Young notes that technology in this country is largely an export industry, so a resurgence in the U.S. economy and weakness in the Canadian dollar will have a two-part positive impact. As well, he says the tech sector tends to see stronger demand in the second half of the year, because of the timing of information technology budgets and sales pushes for year-end.
As for the stock that most Canadians associate with our tech sector, there doesn't seem to be much optimism at this time. Mr. Young notes that the Canaccord team has had a sell rating on BlackBerry since December. Mr. Hodgins says BlackBerry "looks cheap" on an asset basis, but he feels the company is struggling to regain market share, and he would wait to see whether it can ramp up its growth rate before investing.