Here’s why it’s worth watching shares of Appen Ltd (ASX: APX), Nanosonics Ltd. (ASX: NAN) and Nearmap Ltd (ASX: NEA).

Tech Shares Sold Down

Over the past few weeks, shares in Australia’s — and the world’s — favourite technology companies have been smoked, with some falling as much as 20% in a month.

I’m not just talking about hyped up shares like iSignthis Ltd (ASX: ISX). I’m talking about real technology businesses with proven business models.

From US leaders like Alteryx (NYSE: AYX) and Okta (NASDAQ: OKTA) down to local companies like Nanosonics Ltd (ASX: NAN), Appen Ltd (ASX: APX) and Pro Medicus Ltd (ASX: PME). It’s been tough going.

Prices Are Down, Time To Buy?

I think it’s important to take the latest price swings in context.

Some of the most popular Aussie and global technology stocks have risen two, three or even 10 times over in the past couple of years — some have grown that much in less than a year!

For long-time shareholders that’s great news. Well done.

For buyers, the reality is almost all of these companies were extremely expensive and many still are.

I don’t mean to say they have high price-to-sales (P/S) or price-to-profit (P/E) ratios. Those measures are not respectable valuation metrics at the best of times, let alone when business models are changing and the companies can scale rapidly.

I’m talking about valuation in a proper sense. That is, focusing on the probable free cash flow generated by these businesses many years into the future.

Valuations Stretched

Even with ‘best case’ assumptions, many — not all, but many — of the most popular technology companies may find it very difficult to grow their operations and justify their current share prices.

For example, our Rask Invest model portfolio owns Pro Medicus. We bought shares around $7.60. By 2023, we forecast the company to generate some serious free cash flow — many multiples more than what it generated in 2019.

That’s great for shareholders and the company.

However, successful investing comes back to the price you pay because no business is worth an infinite price.

Using a risk rate of 9% — which I consider to be quite aggressive for a smaller, fast-mover like Pro Medicus — our valuation for PME shares struggles to push above $15.

Using an internal rate of return (IRR) model, a valuation model which takes dividends and a multiple (e.g. P/E ratio), if Pro Medicus shares trade at 30x profit in 2023 (which is high) I think investors who buy shares today will still struggle to generate a market-beating return.

I don’t think the stretched valuations are limited to Pro Medicus, there are many tech companies in a similar boat. While not quite as bad, companies like Appen and Nanosonics still appear a little too expensive for us.

So for me, the bottom line for shares of companies like Nanosonics, Pro Medicus and Appen is this:

You, the analyst/investor, will have to consider that you’re expecting lofty growth targets to be hit and you’ll have to be prepared to buy the shares for 5+ years.

Alternatively, you can do what we’re doing and keep watching the shares closely to wait for a better opportunity. In the meantime, you can look at other share ideas and cover more of the market…

Next Steps

Knowing that there are thousands of companies on the ASX (and more overseas), many with promising futures, I’m not in a rush to buy anything. I believe there will come a time to buy shares in Australia’s tech companies at more compelling valuations.

Maybe not the same prices. But better valuations. Remember, the price is what you pay but the value is what you get.

And let’s be real.

Unlike professional money managers, individual investors like us don’t have anyone to please, it’s our money. We don’t have portfolios that must be full of new ideas before the monthly newsletter goes out to clients. And we’re not bound by a set of rules (aka a “mandate”) that prohibits us from investing in certain things.

That’s really good news because I believe better opportunities will continue to present themselves outside of the usual suspects going forward.

For Rask Invest, in the past month alone I bought a second parcel of shares in an ASX-listed company worth less than $250 million. It’s run by a highly experienced owner-operator with heaps of skin in the game.

I know of only two professional money managers who own shares in the company. That’s because the company is not a usual suspect and it’s far too small for most big fund managers to buy.

To me, these small but growing companies are the perfect complement to my core, defensive holdings in solid blue chips and low-cost, high-yielding dividend ETFs.

Who says you can’t have the best of both worlds?

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Disclaimer: Any information contained in this article is limited to general financial/investment advice only. The information has not taken into account your specific needs, goals or objectives, so please consider consulting a licenced and trusted adviser before acting on the information. Please read The Rask Group’s Financial Services Guide (FSG) for more information. This article is authorised by Owen Raszkiewicz of The Rask Group, which is a corporate authorised representative No. 1264179 of Strawman Pty Ltd (ACN: 610 908 211) (AFSL: 501 223).

Disclosure: At the time of publishing, Owen owns shares of Pro Medicus.