Australia does not boast a strong information technology industry. Of the 11 major sectors comprising the S&P/ASX 200 index, Information Technology was the smallest, representing a puny 0.6 per cent of the index late last month. By contrast, in the US it was the largest sector of the S&P 500 index.

In addition, since the dotcom boom of the late 1990s, local investors haven't always viewed many of our high-tech stocks as worthy long-term investments.

Yet Australia has some excellent technology companies. Many of them have struggled during the economic downturn as customers cut back on their capital spending and share prices plummeted. However, they are now generally in recovery mode and although some share prices have risen substantially, analysts agree value can still be found.

A senior research analyst at Ord Minnett, Richard Ivers, divides the information technology sector into three broad categories: hardware (not well represented on the Australian market), software and services.

It is the services companies – such as Oakton, SMS Management and Technology and DWS Advanced Business Solutions – that were hit the most when the economy faltered.

“Their business is often project-based and they are reliant on capital and operational expenditure from their customers,” Ivers says. “When times become tough, capital expenditure tends to get cut back.”

Thus, Oakton saw its after-tax profit slump by 48 per cent in the financial year to June. But big companies and government departments cannot postpone their IT capital spending indefinitely and orders have been trending back up since the April to June 2009 quarter.

“It is a sector we like at the moment,” says a director of Foresight Securities, Todd Guyot. “There was underinvestment in IT over the past year or two but we have clearly seen an upturn in activity recently ... a sustainable upturn seems to be in place.”

Looking further ahead, some analysts view the possible break-up of Telstra as having an impact on the sector.

“Telstra is a big client of a lot of these companies and it drives a lot of spend in the sector,” says the manager of the Pengana Emerging Companies Fund at Pengana Capital, Ed Prendergast. “You can turn the break-up into a positive or a negative. Does it mean Telstra stops spending while it sorts out what is going on? Or does the break-up itself open up heaps of opportunities for project-related work? It is a bit of an open query.”

In contrast to the services providers, software companies tend to operate on a business model based on recurring revenues and their financial results are less volatile. However, much depends on the experience and maturity of each company.

“The more mature software companies have a higher proportion of recurring revenues and are less cyclical,” Ivers says. “You are seeing that with the strong performance of software companies like Iress Market Technology and Reckon.”

For investors looking at the information technology sector, a concern will certainly be the strong recent appreciation of some of the stocks.

“A stock like SMS Management and Technology would have been a great buy at $2 or below earlier this year but towards $6 a lot of the potential earnings recovery is already factored into the share price,” he says. “I would say the same with Oakton. When no one wanted to buy it at 80 cents or even lower it was a great stock. Now at $4 a lot of the upside is in the price.”

Both Ivers and Guyot recommend DWS Advanced Business Solutions. Guyot also likes ASG Group. “It is pretty attractively priced at the moment,” he says.

Among software stocks, Ivers recommends Reckon. “Its largest competitor, MYOB, put through pricing increases of around 15 per cent from October,” he says. “If you assume that Reckon puts through the same pricing increase next March then we could be upgrading earnings by about 15 per cent.”

The research director for the Intelligent Investor newsletter, Greg Hoffman, recommends software company Infomedia. “They have all the characteristics that you would like to see in a high technology company, such as big fat margins and a very conservative balance sheet," he says. "They offer a decent dividend yield – almost 7 per cent, fully franked.”