To determine the growth prospects of a technology company, start with three common questions, says Mark Lin, vice president and portfolio manager at CIBC Asset Management.
Those questions are:
- Does the company experience secular growth? Look at whether its growth is expected to continue over the next five years, says Lin, or whether it might be difficult to predict the company’s growth patterns even one year from now. (Read: Help investors understand key global themes for 2015)
- Is that growth consistent? Once you determine the company’s growth isn’t short-lived, he adds, the next step is to make sure there isn’t too much cyclicality. In other words, check whether the company or industry will continue to grow year-over-year with little fluctuation. Also, examine whether the company’s earnings and revenue growth would decline during an economic downturn. (Read: Look to low-vol for long-term returns)
- Does the company have staying power? For this to be the case, the company has to generate a lot of cash, says Lin. “That’s how we valuate companies over time. The company actually has to produce profit in the form of cash, not just in the form of accounting profit.” (Read: Which Canadian companies should you buy?)
Where to invest
Currently, Lin finds credit card processing companies offer investment opportunities. “It isn’t hard to imagine that electronic cash will continue to substitute paper money, and that’s because our banking system is evolving. Think of all times you use your credit card to buy a cup of coffee or something on the [Internet] through Amazon, or to book a trip.”
So, he doesn’t see this trend changing over a multi-year period, especially since emerging markets with large paper circulations are also seeing increased use of electronic money.
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Investors can add exposure to companies such as Visa and Mastercard, the top two operators in the market, says Lin. “There are very high barriers to entry, and both companies are extremely profitable. Their valuations are fair compared to their growth, so both companies definitely aren’t undervalued at this point. But we can pay a fair price.”
And, “as these companies continue to generate growth in cash earnings, their intrinsic values will go up. Therefore, if both stay on [their] current trajectory, their stock prices should follow this trend in coming years.”