After technology stocks got clobbered in 2022, they’re now starting to show signs of an upswing. But luckily for investors looking to put money to work within the group, many high-quality tech companies are still trading at discount prices. That includes the stocks of familiar tech giants such as Microsoft MSFT and Salesforce CRM.
To find undervalued, high-quality tech stocks, we screened the Morningstar Wide Moat Focus Index—a collection of stocks with Morningstar Economic Moat Ratings of wide that are trading at the lowest current market price/fair value ratios.
Economic moats reflect the degree to which a company has durable competitive advantages. A company with an economic moat can fend off competition and earn high returns on capital for many years to come. Morningstar analysts assess companies as having a wide moat, narrow moat, or no moat.
The combination of wide economic moats and low valuations has proved to be a winning mix over the long term. The Morningstar Wide Moat Focus Index, which contains quality undervalued stocks from nine different equity sectors, was up 2.3% for the trailing 12-month period through Feb. 14, 2023, while the broader market was down 5.5%, as measured by the Morningstar US Market Index. And in 2022, the Wide Moat Focus Index fell 13.1%, outperforming the broader market, which fell 19.4%.
Even as the wide-moat focus group has outperformed through the bear market, analysts say the technology stocks on this list still have room to run.
What Qualifies as a Technology Stock?
The tech stocks are of those companies engaged in the design, development, and support of computer operating systems/applications as well as companies that provide computer and tech consulting services. It also includes those who manufacture computer equipment, data storage and networking products, semiconductors, and components. There are four industries within the technology sector included in this index. Those industries are semiconductor equipment and materials, semiconductors, software―application, and software—infrastructure.
Undervalued, High-Quality Tech Stocks
A screen of the Morningstar Wide Moat Focus Index reveals the most-undervalued technology stocks that have durable competitive advantages. Here are eight tech stocks from the index that have Morningstar Ratings of 4 or 5 stars and wide moat ratings:
- Teradyne TER
- Tyler Technologies TYL
- ServiceNow NOW
- Salesforce CRM
- Guidewire Software GWRE
- Workday WDAY
- Lam Research LRCX
- Microsoft MSFT
The most undervalued tech stock is Teradyne, trading at a 36% discount to its analyst-assessed fair value estimate. The least undervalued on the list is Microsoft, trading at a 12% discount.
Teradyne
- Industry: Semiconductor Equipment and Materials
- Stock Price: $108.01
- Fair Value Estimate: $167
“Teradyne is a heavyweight supplier of automated test equipment for semiconductors, boasting market-leading capabilities that run the gamut of chips. It is one of two companies worldwide that can produce testers for the most cutting-edge semiconductors, thanks to robust engineering talent across hardware and software and a structural lead in organic investment. The firm is a vital partner to chipmakers across the industry and has an impressively strong relationship with Apple AAPL and Taiwan Semiconductor Manufacturing Company TSM. Teradyne’s market leadership exhibits itself in industry-leading margins, strong returns on invested capital, and a top market share. We give the firm a wide economic moat rating.
“The firm faces uncertainty arising from the cyclical semiconductor market, which accounts for a majority of sales. In periods of lower demand, chipmakers could tame their capital expenditures, lowering demand for Teradyne’s testers. Teradyne is less vulnerable to cyclicality than a chipmaker—being one degree of separation removed from chip demand—and its customers make long-term investments in its testers that we don’t think would be significantly altered in a short-term downturn. We think Teradyne’s customer concentration is a risk. Its five largest customers account for roughly 30% of sales, with TSMC and Apple being the largest, and Qualcomm QCOM being another. If Teradyne were to lose one of its large customers, it would be a material detriment to revenue. That said, we don’t foresee a scenario where Teradyne would lose a whole customer in one fell swoop. Most customers dual-source, and changes between suppliers happen at the product-line level, making share shifts incremental. We believe Teradyne’s competition with Advantest ATEYY poses a risk. We don’t expect either firm to exhibit irrational competitive behavior, but if Teradyne’s rate of innovation were to slow, it could spur enduring market share losses to a well-capitalized competitor.”
—William Kerwin, analyst
Tyler Technologies
- Industry: Software—Application
- Stock Price: $326.19
- Fair Value Estimate: $500
“We view Tyler Technologies as the clear leader in a slow-moving and underserved niche market of government operational software. We believe there is a decadelong runway for normalized top-line growth near 10% at Tyler, especially as demand for software as a service accelerates and the need to modernize local governments’ legacy enterprise resource planning systems intensifies.
“While competition is always a risk, we believe Tyler is somewhat insulated from competition as local governments and public institutions have continued to push off investing in new systems as long as possible, and the maintenance of legacy systems is often no longer an option. Additionally, while there are a variety of localized competitors, there are no pure-play national government software providers with Tyler’s scale. As Tyler continues to benefit from larger deals, we believe it will bump into the larger horizontal software companies more frequently.”
—Dan Romanoff, senior equity analyst
ServiceNow
Industry: Software—Application
Stock Price: $461.35
Fair Value Estimate: $600
“ServiceNow has been successful thus far in executing a classic land-and-expand strategy. First, it built a best-of-breed SaaS solution for IT service management, or ITSM, based on being modular and flexible, having a superior familiar user interface, offering a way to automate a wide variety of workflow processes, and becoming a platform to serve as a single system of record for the IT function within the enterprise. Having established itself in ITSM and then the much larger IT operations management, or ITOM, market, the firm moved beyond the IT function. The same set of product design features and technologies has allowed ServiceNow to bring its process automation approach to human resources service delivery, customer service, finance, and operations. More recently, ServiceNow has been offering higher pricing tiers with an increasing array of features, along with industry specific vertical solutions, which have higher average selling prices and help drive revenue growth.
“We believe the most important metric for ServiceNow investors is revenue growth. Therefore, continued deceleration in subscriptions, or growth that does not materialize as expected in PaaS or emerging products, would likely have an adverse impact on the stock, in our view. Within the software industry, we have seen companies at times struggle to manage rapid growth.”
—Dan Romanoff, senior equity analyst
Salesforce
- Industry: Software—Application
- Stock Price: $169.96
- Fair Value Estimate: $220
“After introducing the software-as-a-service model to the world, Salesforce has assembled a front-office empire that it can build on for years to come, in our view. Sales Cloud represents the original salesforce automation product, which streamlined process management for sales leads and opportunities, contact and account data, process tracking, approvals, and territory tracking. Salesforce’s critical differentiator was that the software was accessed through a web browser and delivered over the internet, thus inventing the SaaS software delivery model. Service Cloud brought in customer service applications, and Marketing Cloud delivers marketing automation solutions. These solutions encompass nearly all aspects of customer acquisition and retention and are mission critical. Salesforce Platform also offers customers a platform-as-a-service solution, complete with the AppExchange, as a way to rapidly create and distribute apps. We believe this further strengthens the substantial community of Salesforce users.
“Salesforce will benefit further from natural cross-selling among its clouds, upselling more robust features within product lines, pricing actions, international growth, and continued acquisitions such as the recent deals for Slack and Tableau. Salesforce is widely considered a leader in each of its served markets, which is attractive on its own, but the tight integration among the solutions and the natural fit they have with one another makes for a powerful value proposition. To that end, more than half of enterprise customers use multiple clouds. Further, customer retention has gradually improved over time and is better than 92%, which we expect to grind higher still in the coming years.”
—Dan Romanoff, senior equity analyst
Guidewire Software
Industry: Software—Application
Stock Price: $75.24
Fair Value Estimate: $95
“Guidewire is executing a classic land-and-expand strategy. The company started with the most critical piece, ClaimCenter, which is customer facing and handles claims processing, and then organically layered in BillingCenter and PolicyCenter within the next several years. Today, Guidewire has a broad software suite that covers all areas of an insurer’s needs and offers a wide variety of add-on solutions, with analytics representing an important growth driver.
“We believe industry competition is unusual for Guidewire in that insurance carriers can opt to continue to maintain their custom-built legacy systems, elect a system with a highly customized package from Oracle ORCL or SAP SAP, or explore more direct competitors such as Duck Creek DCT. Given the glacial pace of change, we believe this adds a layer of risk to the disrupter and gives incumbents and legacy providers more opportunities to maintain organizational inertia. Further, any one deal pushed or pulled from one quarter to the next can have a meaningful impact on results.”
—Dan Romanoff, senior equity analyst
Workday
Industry: Software—Application
Stock Price: $189.54
Fair Value Estimate: $229
“We consider Workday to be a best-of-breed cloud-only platform for human capital management, or HCM, software. By debuting in 2005 as a first mover in the cloud HCM space at an ideal time—when enterprises were looking to make the move from on-premises to cloud software solutions—Workday has benefited from its timeliness as well as its high-quality product and reputation for smooth implementations. Now that customers have transitioned to a cloud solution with Workday, we think the possibility of another vulnerable event like the cloud migration that would leave Workday susceptible to customers switching, is unlikely. Instead, we see wide-moat Workday as having robust switching costs which, in our view, will only get stronger as the company builds off its core HCM offering.
“We assign Workday a high uncertainty rating, which is mostly derived from the possibility of facing tougher competition from either incumbents SAP or Oracle catching up to Workday or from new entrants. We think Microsoft could be a threat to Workday eventually. Microsoft currently has an HCM solution called Dynamics 365 Human Resources, which was rebranded in 2020 from its former Microsoft Dynamics 365 Talent Attract and Talent Onboard applications. Latest versions of Office 365 Enterprise come with a feature called MyAnalytics that shares productivity insights on individual employees.”
—Julie Bhusal Sharma, equity analyst
Lam Research
Industry: Semiconductor Equipment and Materials
Stock Price: $516.21
Fair Value Estimate: $620
“Lam Research is a major vendor of semiconductor fabrication tools. The firm is the leader in dry etch, a critical step in the chipmaking process where material is selectively removed. We believe Lam has a wide economic moat as a result of cost advantages and intangible assets related to equipment design. Lam’s leadership position creates scale advantages that fuel research and development spending at levels only Applied Materials AMAT and Tokyo Electron can match. At the end of 2021, Lam had an installed base of 75,000 units, up from 40,000 in 2015. This large installed base creates stickiness and offers Lam an intimate look into problems faced by chipmakers, providing valuable information it can use to implement solutions and additional capabilities in future tools.
“Additionally, the cyclical nature of the chip industry is a threat to equipment makers, as capital expenditures for customers can be highly volatile. Lam competes with the likes of Applied Materials and Tokyo Electron, both of which have invested heavily to improve their products in etch to lessen Lam’s technological lead. Thus, the firm must maintain a large R&D budget throughout business cycles to keep up with the latest trends in chip manufacturing, which could be challenging during downturns. Any lapse in innovation in the segments in which Lam competes could result in failure to defend key positions in customers’ process flows. Meanwhile, the recent adoption of EUV in high-volume manufacturing at logic and foundry customers could negatively affect Lam’s etch and deposition sales related to multiple patterning. Furthermore, the substantial equipment spending in 3D NAND in recent years could result in excess capacity, leading to a slowdown in Lam’s sales to this end market (as occurred in 2019).”
—Abhinav Davuluri, strategist
Microsoft
Industry: Software—Infrastructure
Stock Price: $272.17
Fair Value Estimate: $310
“Since taking over as CEO in 2014, Satya Nadella has reinvented Microsoft into a cloud leader such that it has become one of two public cloud providers that can deliver a wide variety of PaaS/IaaS solutions at scale. Additionally, Microsoft embraced the open-source movement and has largely transitioned from a traditional perpetual license model to a subscription model. The company has also enjoyed great success in upselling users on higher-priced Office 365 versions, notably to include advanced telephony features. These factors have combined to drive a more focused company that offers impressive revenue growth with high and expanding margins.
“Microsoft faces risks that vary among the products and segments. High market share in the client-server architecture over the last 30 years means significant high-margin revenue is at risk, particularly in OS, Office, and Server. Microsoft has thus far been successful in growing revenue in a constantly evolving technology landscape and is enjoying success in both moving existing workloads to the cloud for current customers and attracting new clients directly to Azure. However, it must continue to drive revenue growth of cloud-based products faster than revenue declines in on-premises products.”
—Dan Romanoff, senior equity analyst
The author or authors do not own shares in any securities mentioned in this article.Find out about Morningstar’s editorial policies.
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