Although people in the twenty-first century are used to tech products, a bit of caution needs to be exercised when choosing to buy stocks of tech companies. It can be a high-growth industry, and with it come rapid fluctuations in a stock’s value. Tech stocks can be big winners, and at worst of times be big losers.
Over the past decade, e-commerce giant Amazon rallied nearly 2500% and consumer tech favorite Apple appreciated 1000% percent. While these two companies did something right, others crashed within the same period. It is this unpredictability of tech stocks that investors are required to exercise caution.
If you’re new to investing, and you’re thinking of investing in your favorite tech companies, this guide can help.
Understand what the company does
One of the reasons why the 1990’s dot-com bubble burst was because people continued investing in new Internet-based companies without understanding the business plan. A majority of investors plunked large amounts of money in untested tech companies. They did so because of the exponential growth of other tech companies.
The dot-com bubble event shows that blindly following the herd won’t do any good. Even if a financial analyst strongly recommends buying a particular tech stock, if you don’t understand its business, don’t do it. As legendary investor Warren Buffett said, “Never invest in a business you cannot understand.”
Consider the market leaders
Consider investing in the market leaders, which have a strong chance of keeping smaller rivals at bay. They are the best in their class, which means that they have stable margins and strong pricing power. Strong margins and pricing power are a winning combination in the cutthroat world of business.
Look to the future
As an investor in tech stocks, it’s always in your best interest to keep up-to-date with the latest tech news, especially innovations done by the companies in which you’ve invested, as well as their competitors. This practice will give you a bird’s eye view of the small but significant shifts in the tech world and whether the companies you’ve chosen are doing well.
You may be familiar with what happened to former market leaders Blackberry and Nokia, both of whom controlled a huge chunk of the smartphone and feature phone market. Both companies were edged out of the market after accepting that they wouldn’t be able to keep up with the competition. Consumers preferred their competitors’ increasingly innovative products.
A good rule of thumb is to watch out when a tech company stops innovating and chooses to follow market trends. When it does just the bare minimum, its high-growth days may be over.
Build your portfolio on a solid foundation of “old tech.”
Many investors focus on the hot and new companies. However, there are a good number of slow-growth yet reliable tech companies. Intel, IBM, and Microsoft have been around for many years. These “old tech” giants are reliable sources of income; they are known to regularly raise their dividend payouts and trade at a much lower price than fast-growing new tech companies. It is companies like these that should make up the core of your portfolio.
Understand how these stocks are valued
Investors often make no qualms about paying a premium price for high-growth tech stocks. However, most financial advisors argue that a comparable growth in earnings should back these stocks.
Getting a good grip on a company’s valuations can be tricky especially when they post explosive sales growth along with widening losses. In cases such as these, investors should check the company’s cash position and free cash flow to better analyze the health of the business. You can find this information in the company’s annual reports and other financial statements which are readily available on the publicly held company’s website.
While the tech sector might seem overwhelming at first, you can safely stand on the ground of a few time-tested rules: buy what you understand, identify the market leaders as well as the disruptors, and know the health of the company. Combine these with solid research, and you’re sure to possess good tech stocks in your portfolio that will earn good returns for you in the long run.