Keys to Investing in Technology Companies

In the following commentary, the Portfolio Managers of the Hennessy Technology Fund Portfolio discuss the Fund’s strategy, investment process, and portfolio construction.

January 2021
  • Ryan C. Kelley
    Ryan C. Kelley, CFA
    Chief Investment Officer and Portfolio Manager
  • L. Joshua Wein, CAIA
    L. Joshua Wein, CAIA
    Portfolio Manager

How does the Hennessy Technology Fund differ from its peers?

While many of the Fund’s peers are focused on identifying emerging technologies and the companies that could capitalize on these trends, the Hennessy Technology Fund is focused on companies that have already demonstrated an ability to generate profits and cash flow. Since trends in technology can be quite volatile, we feel that selecting profitable companies with solid balance sheets makes sense over time. In addition, many peers focus solely on the Information Technology sector, while our Fund seeks opportunities more broadly.

Would you please describe the type of Technology stocks in the portfolio?

The Fund’s holdings are selected from the Information Technology sector as well as three sub-industries within the Consumer Discretionary and Communication Services sector, including internet and direct marketing, interactive home entertainment, and interactive media and services. The portfolio’s large opportunity set allows for exposure to not only large well-established companies but also small and mid-cap companies with potentially long growth runways.

What are the most important criteria for investing in technology companies?

We believe that there are many metrics on which to focus when investing in technology companies. Given the complexity of many of these companies, we utilize a handful of key investment criteria designed to evaluate cash flow, profitability, balance sheets, and valuations. First, we rank our investable universe from best to worst on these criteria and pick the top-ranked stocks. Second, we score those top-ranked stocks by certain metrics using an equally weighted scoring model and pick the top 60 ideas for inclusion in the portfolio.

What specific metrics do you utilize when selecting portfolio holdings?

The Fund seeks high-quality companies that have the potential to participate in the growth and innovation of technology. We utilize several metrics to analyze Technology companies with market capitalizations over $175 million, selecting the top 60 stocks that demonstrate the following:

  • Sector-leading cash flows and profits, with the ability to sustain profitability
  • Attractive balance sheet risk profile
  • A history of delivering excess returns over the cost of capital
  • Attractive relative valuation
  • Ability to generate cash

Within the Technology sector, many companies have historically experienced a high level of price volatility. Based on our extensive research, we have found that a focus on companies that can generate a high level of free cash flow can help minimize volatility.

As a result of our stringent criteria, the Fund is comprised of stocks ranging in market capitalization from $250 million to over $1trillion. As of December 31, 2020, the Fund had a median market cap of approximately $19 billion and an average market cap of $139 billion.

Would you please discuss why the Fund holds just 60 stocks?

We hold 60 companies as we aim to provide a balance of returns, diversification, and volatility. In our extensive analysis of past performance, we believe that maintaining a fairly concentrated portfolio gives investors the best opportunity to outperform the overall Technology sector while potentially limiting downside risk.