Making money and a willingness to spend it on R&D are two of the key traits a solid tech company should embody in 2020, one analyst says.

RBC Capital Markets analyst Garry Sherriff says high performing public technology sector companies this year exhibit one or more of the following traits:

  1. Material organic sales growth;
  2. High recurring revenue;
  3. Continue to invest in R&D and product innovation;
  4. Have a pathway to becoming a top three global player in their field with strong management teams to execute the vision; and
  5. Trade at reasonable forward growth-adjusted multiples.

“The key focus for investors in 2020, in our view, is subscriber growth, sales growth and increasingly free cash flow generation,” Sherriff said in a note.

There are several headwinds the tech sector must deal with, however.

Volatility is one, given uncertainties around geopolitical tensions and technology regulation, although low interest rates globally are a good sign for growth stocks — of which there are few outside technology.

The US presidential election in November should be preceded by some positive trade deal news while certainty around Brexit and the low Aussie dollar are “likely a positive tailwind for markets”.

Expensive technology stocks is a risk, as are the regulatory inquiries into the major US technology names.

“Although not directly impacted, Australian technology stocks are indirectly affected from an investor-sentiment viewpoint, which can materially affect trading multiples and share prices,” Sherriff wrote.

All of Sherriff’s top picks are large caps: Xero (ASX:XRO), Altium (ASX:ALU), Megaport (ASX:MP1), Pushpay (ASX:PPH), and NextDC (ASX:NXT).

However he has his eye on some small caps too, with caveats.

For payroll software company Elmo (ASX:ELO), Sherriff is keeping an eye on increasing competition from larger rivals and management’s execution of shifting the sales strategy to smaller customers.

“Multiple acquisitions make it harder to disentangle organic from acquired growth,” he said.

Hansen Technologies (ASX:HSN) is a “low organic growth story and margin improvement looks like a multi-year process,” according to Sherriff.

“Outside of potential acquisitions, we can’t see many near-term catalysts.”

Citadel (ASX:CGL) had a disappointing 2019, with multiple downgrades, and CEO and board departures. Sherriff says it is a managed IT services story with “aspirations of shifting to more recurring revenue streams” and he is awaiting a strategy and pipeline update.

Sherriff is also looking for signs of Superloop (ASX:SLC) executing on its named strategy in the first half of 2020, now it has repaired its balance sheet.