The tech sector has been a top performer for investors for years, but it has also been home to major busts. We can look at busts from the telecom bubble to the early dot-com bubble, but there are others. This shouldn’t be a surprise given how large and diverse the “tech” sector is. Even accredited investors wonder which emerging technologies they should invest in. Here are five things you should know before investing in the tech sector.
Don’t Focus on the Hot Tech Products
It is a serious mistake to focus on hot tech products, regardless of what they may be. Money is pouring into prominent technologies like blockchain and artificial intelligence. This can lead to bubbles as many cryptocurrency investors are discovering. It also leaves promising valuable technologies like wireless energy desperate for cash. A low-risk, high-return strategy requires investing in a number of technologies and companies that aren’t in the headlines but are likely to yield strong returns.
One solution for tech investors is to accept that hype and irrational exuberance are facts of life, but that they should not determine your investing strategy.
Technological Viability Cannot Be the Only Criteria
Technical viability shouldn’t be the only reason you invest in something. The fact that they built it doesn’t mean the rest of the world will find it relevant. After they build it, which businesses or consumers will buy it? The honest answer will not be “everyone”.
Technology that radically improves manufacturing may be of value and bought by manufacturers, but this still requires it to be better than what they’re using in some regard and within their price tolerances. And technology that revolutionizes the financial industry isn’t going to be of much use to general manufacturers.
What is the business case for the technology? How big will the market be? Will those who make it or deliver it be able to earn a profit? Is there a sound business model behind it? In contrast, a cool device that only sells for a while as a novelty may not be worth much after the novelty wears off, and that’s assuming it can be sold as a novelty. Then you’re hoping the item can leverage brand recognition or explode onto the market.
Always assess the technologies in business terms. And recognize that there is no substitute for good management, regardless of how good the technology may be. Even if the company has a good lead today, inept management will cause it to fall behind companies with better leadership. Conversely, an investment in a firm run by good leadership is an investment in the profitable future they’re likely to create.
Look at the Long Term Potential
Before you invest in a technology related business, look at whether or not it can maintain its pricing power over the long term. Can someone clone it and undercut its profit margins in a few months? Will there still be a market after they’ve been selling it for a year or two? Could the technology become obsolete in a short period of time due to a new competitor? The ideal technology investments are those that solve large, real world problems that nothing else can. Then they’ll be in wide demand for a long time.
You should also be able to see the opportunity in uncertainty. If a business has a solid business model that isn’t being undermined by a new technology, you could use dips in the stock price due to bad news or hysteria as a buying opportunity. However, if a business is truly going downhill, you should be selling and not buying. What matters in these cases is perspective.
Slow moving technologies are an example of when perspective can make all the difference. Self driving cars and virtual reality have had their initial revelations, but they’re experiencing speed bumps. However, once the groundwork for it is finally in place, the technology could cause serious disruption in a short period of time. If that groundwork is steadily being laid, you should consider investing in these developing technologies.
Consolidation Is On-Going
The tech industry is seeing a lot of consolidation, and many of the purchases are not always what the average investor expects. Tech companies are buying up rivals and startups in software, hardware and services to ramp up their competencies. A wave of acquisitions is also happening to create “ecosystems” to keep customers engaged. The goal in these cases is for the tech giant to deliver everything from hardware to software to support, controlling all aspects of the user’s experience and profiting from each.
For example, hardware and software vendors are moving into the Internet of Things while simultaneously investing in data analysis and connectivity. Your computer, home automation system and smartphone could all end up connected and working together – by design, and it could all be powered by the same firm. A number of tech companies are even buying up entertainment companies so that the customer stays in their corner of the internet.
Buying a company in the hope it is acquired is a high risk proposition, but it is a viable strategy in technology if you buy the right stocks. Michael Robinson investor and Silicon Valley insider has a track record of identifying firms like this; he also discusses technology trends that are creating opportunities for investors.
Remember the Smaller Players
The creation of technological “ecosystems” is shaping the fortunes of companies large and small. Small companies that aren’t acquired by big ones but do a lot of business with the large firms are excellent places to invest. While the company’s valuation matters, growth rates and investment plans matter as well. And smaller businesses that have a good business plan and likely strong future growth are an excellent place to invest.
The odds are much higher that you’ll see significant return on the investment in dividends and capital appreciation if you buy a smaller company trading at several times its earnings than the Big Tech firm selling at eye-popping EPS multiples with little regard to their profit margin. To find these investment opportunities, look at the company’s sales or EPS now and the projected values for the next couple of years.
The corollary to this is avoiding companies that seek to challenge a big company with an established ecosystem. Focused startups sometimes succeed when challenging a large but unfocused company. However, as an investor, you need to weigh the odds of the potential success of the small firm before investing in it.
The technology sector is significantly different than other major sectors. It is subject to more rapid change, potentially fast growth for companies of all sizes, and shifting ecosystems. This makes it a more difficult area for investors but provides amazing opportunities as well.