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Where to find opportunities in tech stocks

As the biggest technology trends evolve, potential investment opportunities have shifted.

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The biggest innovations in the technology space are profound: more shopping online, more companies moving to the cloud, and people spending more time on mobile phones.

But with huge growth baked into the prices of many tech stocks and fierce competition throughout the industry, it’s important for investors to be strategic and focused on the next phase of growth for these trends. Among the possibilities: narrow industry-specific cloud applications, services to help small businesses compete online, and the transition from smartphone adoption to apps.

E-commerce for mom and pop

We all know the Internet is taking share from traditional retailers. The giants in the space have arrived, with companies like eBay, Alibaba, and Amazon casting global shadows. Fidelity Fund Manager Kyle Weaver, who runs the Fidelity® Select IT Services Portfolio (FBSOX), says that beyond the leading virtual retailers, he sees another approach to investing in the growth of online retail—companies that will help small businesses compete.

The ubiquity of the Web means that even small local businesses need to be online. But according to Web services provider Web.com (WWWW), just 26% of small businesses currently have an online presence. The challenge for small businesses is that simple Web pages might not do the trick. Today’s consumers will demand sophisticated functionality, like online scheduling and ordering, search engine optimization, social network presence, and more.

“To continue to be successful, a huge number of small businesses will need to establish a bigger Web presence,” says Weaver. “These companies will look to service providers who can help them manage the challenge without requiring them to have technical skills.” That points to Web services providers who can produce low-cost but sophisticated sites for businesses with no technical skills.

In the cloud: opportunities for consultants

Cloud computing—a model in which businesses or individuals store data and purchase applications on remote servers instead of their own hardware—has continued to displace hardware spending and other IT investments. The three major parts of cloud computing—Software as a Service (SaaS), Platform as a Service (PaaS), and Infrastructure as a Service (IaaS)—are all poised to gain and all appear to have the potential to grow for many years. (See the chart below).

SaaS in particular looks poised for rapid growth. The leading SaaS companies include well-known names such as Workday and Rackspace. But a new second wave of opportunities may also be emerging among more specific software applications.

“The first wave of SaaS offerings were broad-based applications: human resources, marketing, and customer service,” says Brian Lempel, manager of Fidelity® Select Software and Computer Portfolio (FSCSX). “Now, things are getting deep with vertical SaaS companies that produce highly specialized offerings for individual industries—health care, real estate, or insurance, for example.”

The growth of cloud computing is also creating an opportunity for less direct plays. For instance, Weaver says that traditional IT service providers are well positioned to help clients learn to use these emerging technologies efficiently and effectively.

Many of these stocks have been punished, in part due to concerns that they will lose some revenue because they will no longer manage implementations of new software. But Weaver says there may be a silver lining on the consulting side of their businesses that the market isn’t fully valuing.

“As companies replace their technology stack, it will present a headwind for traditional services companies, but they still have healthy business process outsourcing services, and their job is to figure out where to have expertise next to be of service to their clients,” says Weaver. “Nobody loves spending money on consultants, but they are there for a good reason.”

Mobile transitions to apps and advertisements

For most of the last decade, the move into smartphones has proceeded at a breakneck pace. But increasing competition among phone manufacturers and saturation in some markets should start to slow the growth of sales for smartphone units themselves—particularly in the developed markets where handset manufacturers earn the highest margins. Penetration is expected to continue to grow in emerging markets, though profit margins are lower there.

There may also still be significant growth ahead for other trends connected to mobile, in particular advertising and apps.

Today, people are spending more time on their phones than they are on their computers. Some analysts had been worried that leading mobile applications would not be able to translate users into advertising revenue, but it looks like over time mobile ads will likely turn out to monetize better than desktops. “Advertising money follows eyeballs, and this should be a big tailwind for companies like Google and Facebook,” says Lempel.

Mobile applications are also exploding. The market didn’t exist in 2007, but could surpass $70 billion in 2017, according to Lempel. The leading app ecosystems, Google’s Android™ and Apple’s iOS, capitalize by taking a cut of each transaction.

“I expect that Apple and Google could both benefit from this trend toward apps, and the potential exists for many years of continued growth as these two ecosystems become more entrenched with users and better monetized through applications, advertising, and payments,” says Lempel.

Bottom line

The technology industry continues to shift, with major changes transforming the way businesses and individuals communicate, shop, and go about their business. These changes are well known, but as they evolve and play out, new investments opportunities will emerge.

Learn more

  • Brian Lempel manages Fidelity Select Software and Computer Services Portfolio (FSCSX).
  • Kyle Weaver manages Fidelity Select IT Services Fund (FBSOX).
  • Find mutual funds, ETFs, and individual stocks in our research centers.
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Information provided herein is general in nature, is provided for informational purposes only, and should not be construed as investment advice. The views and opinions expressed by the speakers are their own as of August 5, 2014, and do not necessarily represent the views of Fidelity Investments. Any such views are subject to change at any time based on market or other conditions.
Fidelity Investments disclaims any liability for any direct or incidental loss incurred by applying any of the information provided here.
As with all your investments through Fidelity, you must make your own determination as to whether an investment in any particular security or securities is consistent with your investment objectives, risk tolerance, financial situation, and your evaluation of the security. Fidelity is not recommending or endorsing this investment by making it available to its customers.
Kyle Weaver manages the Fidelity IT Services Fund, which invests in some of the companies mentioned in this article. As of June 30, the fund held shares of Web.com (2.6% of the fund); Endurance International Group Holdings, Inc. (3.9%); Wix.com Ltd. (0.3%); and Workday, Inc., Class A (0.01%).
Brian Lempel manages Fidelity Select Software and Computer Services Portfolio, which invests in some of the companies mentioned in this article. As of June 30, the fund held shares of Google, Inc., Class C (12.7% of the fund); Google, Inc., Class A (8.3%); Web.com (2.6%;) eBay (0.263%); Wix.com Ltd. (0.2%); and Workday, Inc., Class A (0.053%).
The technology industries can be significantly affected by obsolescence of existing technology, short product cycles, falling prices and profits, competition from new market entrants, and general economic conditions.
Past performance is no guarantee of future results.
Investing involves risk, including risk of loss.
Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. Investing in stocks involves risks, including the loss of principal.
Because of their narrow focus, sector funds tend to be more volatile than funds that diversify across many sectors and companies.
Third-party marks are the property of their respective owners; all other marks are the property of FMR LLC.
Votes are submitted voluntarily by individuals and reflect their own opinion of the article's helpfulness. A percentage value for helpfulness will display once a sufficient number of votes have been submitted.

Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917

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