Led by the FAANG group of stocks, the tech sector in the United States continues to get plenty of attention, but north of the border the picture is much different, says BMO Canadian Small Cap Equity Fund manager Tyler Hewlett, who argues that tech’s low profile in Canada presents the savvy investor with tonnes of opportunity.
Tech’s dominance over the American markets seems to grow by the day, as stocks like Facebook, Apple, Amazon, Netflix and Google (Alphabet) are once again responsible for lifting market returns this year. And while Canada does have a few tech names of note — Shopify, Constellation Software, OpenText — they’re ultimately getting less of the press than they deserve, says Hewlett, who spoke to BNN Bloomberg on Canada’s small cap market.
“Tech tends to make up about three per cent of the benchmark in either small- or large-cap [in Canada],” Hewlett says. “We tend to be less benchmark focused. For us, we just try and find the best ideas wherever we can find them and because there have been a lot of positive fundamentals, strong growth, strong free cash flow, we’ve been able to find some of our best ideas from the tech sector.”
“When you look at the Canadian market, particularly within the large cap space but also in the small cap, Canada tends to be very overweight resources,” he says. “And resource stocks over very, very long periods of time have not been the best performers. So, from a market perspective, a lot of it has to do with your view on resources.”
And while the rise of the FAANG stocks and the bloated valuations may be unnerving to some investors, particularly those leaning towards a value investing strategy, Hewlett says that much of that worry is misplaced, since today’s tech giants are on firm ground in terms of fundamentals.
“The thing that’s on most investors’ minds is how sustainable this is,” he says. “What we would say is there has been a lot of talk about valuations of tech stocks and the momentum of tech stocks and how they’ve really been driving much of the market performance. But what most people haven’t focused on is the fundamentals, which are very, very strong in that space, as well.”
“The tech market, particularly in the US, makes up about 25 per cent of the market, but the free cash flow growth, the incremental free cash flow of the market from the software and tech space is actually over 50 per cent,” he says.
“We tend to focus on companies that have good growth prospects. So, while tech doesn’t make up a large part of the Canadian market or a large part of the Canadian small cap market, we’ve always been significantly overweight [in tech] from a bottom-up, from a fundamental perspective,” he says.
Hewlett points to Waterloo-based Descartes Systems (TSX:DSG) as a prime example of an under-the-radar Canadian success story.
“It’s been a fantastic stock,” Hewlett says. “They serve the global trade in the logistics market with very large blue-chip customers — Home Depot, Coca-cola — and this has been a company that hasn’t missed a quarter in over ten years, free cash flow has been very strong, they’ve been able to do a good job of growing the business, and the stock has reflected that over time.”