Technology stocks a compelling investment opportunity

Frank explains, "Inflation is considered a headwind to the markets and to corporate earnings, but stocks also represent companies with real assets and pricing power. Instead of spending much time trying to work out where the economy is going, we prefer to focus on finding high-quality smaller companies that are selling at what we perceive to be significant discounts to their worth as a business. One example is technology stocks. Although the small-cap Russell 2000’s technology sector outperformed the index as a whole in the fourth quarter of 2010, and has done so year-to-date in 2011, we believe the case for technology remains compelling.

"Today’s technology sector is vastly different than the technology sector of more than a decade ago. Back in the late ‘90s technology was viewed by many investors as a permanent growth category that was not subject to the same business cycle dynamics as every other industry. Today, it is nearly the opposite, with investors overly sensitised of its cyclicality. This has created numerous bargains."

Royce believes technology stocks in general have been very inexpensive for several years as they’ve essentially been part of a 10-year bear market. This has allowed Royce to find what it thinks are extraordinary opportunities in companies across a variety of industries. It believe that many investors have lost sight of the fact that technology companies continue to innovate with products and services that save labour and cut costs, both of which are critical in an inflationary environment.

Frank concludes, "Many companies have deferred normal technology upgrades due to the difficult economy, but upgrades are inevitable because ultimately no business can afford to fall behind in technology. In addition, there is growing demand for all types of technology in emerging markets countries that simply did not exist 10 years ago. Many small-cap technology companies currently sport strong earnings and sales growth driven by high foreign exposure and rising business spending. Many small-cap technology companies have pristine balance sheets, with cash as a percentage of market capitalization for the technology sector currently standing at 18%, the highest in the Russell 2000 index."