Manager Insight

Market tends to underestimate revenue growth, Stephen Carlin says.
By Michael Ryval | 24/05/18

The market tends to under-appreciate the long-term potential of some technology players and that's where the opportunity lies, argues Stephen Carlin, lead manager of the 5-star-rated CIBC Global Technology.

About the Author
Michael Ryval, a regular contributor to Morningstar, is a Toronto-based freelance writer who specializes in business and investing.

"Look at a company like Shopify Inc. (SHOP), which targets the e-commerce sector. If you go back two years, analysts' estimates for revenue were around $600 million. But Shopify's revenue came in close to $1 billion," says Carlin, who is also managing director and head of equities at Toronto-based CIBC Asset Management Inc. "Obviously, analysts underestimated the growth in revenues two years out."

Another example is  Amazon.com Inc. (AMZN), the online retail giant. For the past decade its revenue growth has been growing at around 20%, but lately growth has accelerated to around 35%. "There is a long runway for growth for these types of companies," says Carlin, who works within a team that includes Canadian equities analyst Jonathan Mzengeza and senior analyst Michal Marszal. "The growth driver for Amazon has been a relatively new business, AWS, which is in the cloud sector."

Carlin and his team "do a deep dive on a business" and look at longer-term trends. "Our experience has shown that too many investors are focused on the short term, 12 to 18 months," says Carlin, a 27-year industry veteran who joined CIBCAM in 2013 and assumed the portfolio in April 2017. "We use a discounted-cash-flow model that goes out 10 years. We are making certain assumptions. But if we get the longer-term view correct then we have a better view of a business, based on how it's priced today."

Recognizing the potential for growth is critical to the CIBC process. Another example is Kinaxis Inc. (KXS), which has provided real-time supply-management software to the electronics industry but has expanded into the automotive and health-care sectors. "We thought this was a natural extension (for Kinaxis.)"

In scanning the technology-stock universe, Carlin notes that each investment depends on a well researched thesis that is based in key signposts that the team constantly monitors. "We want to ensure that what is being delivered by the business is in fact what we expected."

The research process includes a close study of the size of the market, management's ability to capture the industry segment's growth, and whether its products are market leaders. "We also talk to competitors and discuss how they regard their products against the company we want to invest in," says Carlin. He adds that the team consults external experts to determine the longer-term direction of a company. While the team is very aware of developing trends, such as innovation in software development, it concentrates on the fundamentals that would drive a company's growth.

Carlin contends that luck is not a factor in a company's success. "The stewards of the business will drive its success. It depends on their vision and ability to execute on that vision," he says. "It could be a matter of patents or strong innovative technology. But success does not happen by accident."

The CIBC fund's portfolio of 38 holdings includes stalwarts such as  Microsoft Corp. (MSFT) and  Apple Inc. (AAPL). But Carlin cites less-recognized names such as  Applied Materials Inc. (AMAT), which supplies equipment to semiconductor manufacturers.

"Historically, spending on fabrication equipment has been very cyclical, but since 2014 it has been more robust," says Carlin. "That's driven by a combination of technology changes, capacity additions and China entering the industry. We have seen the rise of artificial intelligence and machine learning and with that you need faster chips, which are more capital-intensive."

In addition, Carlin notes that Applied Materials should benefit from a shift in smartphone manufacturing as organic light-emitting diodes, or OLED, replace conventional light-emitting diode screens. Applied Materials supplies equipment that makes OLED screens.

Another favourite is Shopify, which supplies a so-called "enabling" platform that is geared to small and medium-sized businesses. "People tend to look out only two years and don't believe Shopify's growth can continue for an extended period," says Carlin. "Right now, they have about 600,000 merchants. The average annual growth has been 64% for the past four years. We think there is a long runway for them to grow because they have an addressable market of about 10 million."

Looking ahead, Carlin admits there are macroeconomic forces at work, such as central-bank policies, that could crimp growth. Yet he remains bullish about technology stocks which he believes can continue to grow at double-digit rates.

"We continue to see very strong investment performance in the technology space as a result of those strong top-line trends," says Carlin, adding that even though valuations have crept up a little bit they are not unreasonable. "That will translate into bottom-line growth. That's the key. You need earnings to go higher for stocks to go higher."

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