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Investing in technical stocks: What you need to know



During many years of spirited speculation that led to the dot-com bubble of the late 1990s and 2000-2001, many technology stocks belonged to high-risk companies that failed to make a profit. Today, however, the technology sector includes companies across the full range of economic and operational health, from those still trying to become profitable to established cash cows such as Apple and Facebook .

Sure, tech stocks are still more unstable than those in more established sectors like utilities and consumer goods, but as long as investors are willing to embrace more volatility, there are some amazing companies – and potentially very rewarding stocks ̵

1; to invest in

Therefore, the sector is worth exploring in detail. By understanding what the technology sector entails, including opportunities and threats, the type of shares it includes, how to value a technical stock and more, investors will be well positioned to identify and invest in the industry's most promising stocks. [19659004] The word technology with green capital letters in front of a screen displaying blue data code. "src =" https://g.foolcdn.com/image/?url=https%3A%2F%2Fg.foolcdn.com%2Feditorial%2Fimages%2F539177%2Finvesting-in-tech-stocks.jpg&w=700&op=resize "/>

Image source: Getty Images.

What are tech stocks?

Tech stocks are the listed stocks of companies that sell technology-based services or products. In other words, they represent shares in technology companies that are available for purchase or sale in the stock market.

Stocks in this sector range from those in older technology industries, such as telecommunications and personal computers, to the more beginner segments, such as software-based Internet services and online social networks.

Their business models some companies also produce technological equipment, such as routers and computer processors, others design products but outsource manufacturing, and modern organizations have used creative ways to sell technology. IT services, including subscribing to cloud-based applications, providing access to networks in exchange for ad-supported experiences, paying for online transactions simplified through online marketplaces, and more. [19659010] What types of companies are in the technology sector?

There are many ways to distribute the technology sector, but perhaps the most useful way for investors to look at the market is through the lens of four types of businesses: software, hardware, Internet information and telecommunications.

1. Software Companies

These companies make money selling the programs used by computers. Historically, software was often sold on an à la carte basis. More recently, however, customers are increasingly paying for subscription access to software made available over the Internet. This business model is often referred to as software-as-a-service, or SaaS.

2. Hardware Companies

These companies sell both technology product components and the finished technology products themselves. Examples include semiconductors, servers, computers, smartphones, consumer electronics, computer peripherals, and data storage devices.

3. Internet Information Companies

These companies make money providing content, networks and internet marketplaces. Yelp, for example, provides both a platform for connecting users with local businesses and information about these businesses. eBay for another example, provides an online marketplace for users to buy and sell goods on the Internet.

4. Telecommunications Companies

This industry includes companies that enable communication, primarily through telephone, data and video. However, companies that connect the world through satellite, radio, television broadcasting and the internet usually fall into this category as well.

10 Types of Tech Stocks to Consider Investing in

Looking beyond this 10,000-foot view of the tech sector, investors looking to buy stocks in this space should be familiar with some of the biggest trends in tech stocks. The following 10 technology trends provide investors with topics to look for when deciding which companies to invest in.

1. SaaS

Companies such as SaaS software require customers a subscription or usage fee in exchange to provide access to cloud-based software. Many SaaS companies provide enterprise software, including sales, customer relationship management, inventory management, accounting and collaboration platforms in the workplace.

2. Fintech

Financial technology companies provide software based solutions for various financial services. Some examples include mobile banking, digital payments, peer-to-peer mobile payments, and online budgeting and accounting software. Fintech companies often operate with SaaS business models or cut the transactions done on their platforms.

3. Social networks

Social media gives users access to a network to connect with friends, family, groups, colleagues and organizations. Of course, Facebook is the perfect example of a social networking company. Social media revenue generation models vary, but primary approaches include digital advertising, subscription and a hybrid of these two.

4. Internet of Things

Internet of Things (IoT) refers to Internet-connected and software-powered devices. Thanks to technology and continuous improvements to high-speed wireless internet, ordinary products such as refrigerators, garage door openers and healthcare services now have enhanced features and can be controlled through software via the Internet. Internet of Things companies sell these connected devices and sometimes offer software services to help them.

5. Artificial Intelligence

The convergence of the ability to store huge amounts of data, the continuous development of deep learning algorithms, and advances in graphical processing unit (GPU) computing have led to an era of artificial intelligence (AI). AI technologies and services can learn, adapt, improve and act on their own. Examples include voice assistants, self-driving car technology, customer service chatbots and more. The most relevant companies in this space are the semiconductor companies involved in building the computing power for the development of AI. However, AI is quickly finding its way to many different fields, including transportation, risk management, investment and more.

6. E-commerce

E-commerce refers to selling physical and digital goods and services online. The most direct recipients of e-commerce trends are online stores, online marketplaces that allow other businesses to sell their products, and companies that provide business platforms to build their own online shopping experiences for customers.

7. Connected TV

Connected TV refers to TV streamed over the Internet. This space is growing rapidly because consumers are shifting more of their viewing time to streaming TV as content publishers and advertisers respond to this trend. While Netflix is the most obvious example of a company taking advantage of connected TV, many companies have flocked to the room with a wide variety of business models.

8. Digital Advertising

One of the ways businesses earn on connected TV is through digital advertising, or online advertising. That is why advertisers will eventually spend their money where the consumer is. Increasing use of smartphones, coupled with consumer adoption of streaming TV, video and music services, means that marketers are increasing the spend on digital advertising. Some of the biggest recipients in this market are companies with platforms that help marketers buy and sell ads digitally. However, content publishers also benefit from the revenue generated by ads running on the content.

9. Cloud computing

Cloud computing refers to the provision of data processing services over the Internet. These services come in many forms, including servers, storage, databases and networks that you can access through the Internet. The value proposition for cloud computing companies is that companies can only pay for usage, which helps organizations never over-invest or under-invest in their data capacity.

10. Semiconductors

Semiconductor companies are involved in various aspects of computer processor manufacturing, design and sales, such as central processing units (CPUs) and graphics processing units (GPUs).

Tech sector tailwinds

Two important tailwinds in the technology sector are organizations' digital transformations and cross-sector adoption of e-commerce.

1. Digital Transformations

Companies in all sectors are embracing technology in one aspect or another to improve their businesses. Cloud computing, AI and cloud-based software platforms enable organizations to improve everything from streamlining back-end operations to better customer relationships. This interweaving of technology across organizations is referred to as the companies' "digital transformations."

A wave of non-law companies undergoing these digital transformations benefits many technology companies. This helps supplement the demand for cybersecurity, business software, data and analytics, fintech, cloud computing and AI solutions.

2. E-Commerce Adoption

E-commerce is still a major headwind for many technology stocks. Businesses in virtually every sector embrace e-commerce in one form or another. For example, airlines sell tickets on their websites and on third-party travel booking platforms; brick and mortar retailers implement digital strategies; and restaurants are launching loyalty programs online and delivering food through third-party food delivery devices.

Some of the technology industries that directly or indirectly benefit from the rise of e-commerce include fintech, business software, cloud computing and even digital advertising companies.

Headwinds in the tech sector

Two important headwinds for tech stocks are high employee turnover and lower entry barriers.

1. High employee turnover in software

According to LinkedIn data from 2018, employee turnover in tech (software in particular) is higher than in any other industry. The turnover rate in software-related jobs is 13.2%, according to LinkedIn. The turnover rate for jobs in other major industries includes 11.4% in media and entertainment and 10.8% in both financial services and telecommunications.

problem? High demand for technicians and increasing competition in the industry, says LinkedIns Paul Petrone:

[A] employers and offers become more competitive, top talents are more eager to jump on new opportunities. The numbers support this theory – according to LinkedIn data, almost half (49%) of technology executives are taking another job in the tech sector.

While employee turnover in itself can lead to problems in building and maintaining a stable team, the larger underlying problem created by the competitive environment for technical employees, is the need for organizations to offer attractive compensation packages, often including stock-based compensation on top of regular pay. . As a result, meaningful stock-based compensation has become a common business expense for companies such as Alphabet and Facebook. For some companies, this can lead to significant shareholder dilution over time as the number of total shares increases as a by-product of stock-based compensation.

2. Lower Entry Barriers

Capital-intensive industries, such as automotive, airlines and railways, often require significant investments in front of factories, machines and real estate in order to enter the market. This gives the attendees some competitive advantage, as there are high entry barriers for new entrants.

On the contrary, for many technology companies – especially software providers and Internet information providers – new startups can transform into significant competition for sitting in a very short period of time, and often with a surprisingly small amount of capital. Input barriers in some technology industries are therefore low.

Similarly, this means that large and well-capitalized technology giants such as Apple, Alphabet, and Microsoft can easily distribute new software-based services that could threaten smaller technology companies.

Tech Equity Analysis: Important Calculations and Characteristics to Look For

While there are things that are especially important to look for when analyzing tech stocks, the same basic elements used to invest in equities are still applicable. For example, investors should ensure that a technical stock they are interested in has:

  • A competitive advantage, such as proprietary technology, high switching costs, or a strong brand
  • A solid balance sheet, including manageable debt levels and plenty of cash to weather a challenging season
  • A reasonable valuation (even a great company can be a bad investment if the stock is bought at a price that makes no sense)

Beyond these basic, other metrics and features that are especially important for tech- Shares include gross profit margin, operational leverage, a broad customer base and revenue growth. Here's a look at how investors can check out these factors when analyzing a technical stock.

1. Gross Profit Margin

Because the business models of technology vary so widely from industries (and even within industries), a company can make a significantly different amount of gross profit (revenue minus the direct costs of producing a product or service) on offer than others. To put a company's gross profit into perspective, divide gross profit by revenue to get a metric called gross profit margin.

Gross profit margin gives investors insight into the finances of a company's business. The higher the gross profit, the more lucrative is the company's business model, as long as it can maintain low operating expenses (incurred expenses that are not directly related to the goods or services a company sells, such as sales, marketing and administration costs). The best technology companies often have gross profit margins that are superior to peers in the same industry.

2. Operational Influence

While many technology companies – especially software vendors – have high gross profit margins, a large portion of their expenses may fall under operating expenses. If operating expenses represent a large portion of revenues compared to peers, investors should look for evidence of operating performance.

Operational effort is present when a company's revenue grows faster than its operating expenses. This influence from increasing the size of revenue growth means that over time, more of the company's revenues will fall to the bottom, or net profit after all expenses. When a technology company has operating power, the company's business model is considered scalable. In other words, the business economy improves as revenues increase.

Operational effort is especially important when a technology company is not yet profitable on the bottom line. With the help of operational efforts, an unprofitable technical company has a clear path to profitability, as long as revenues can continue to grow.

3. A broad customer base

Investors should look at a technology company's customer base. Some technology companies – for example, hardware suppliers (especially semiconductor companies or manufacturers of electronic parts) or companies that provide software to companies – may be very dependent on a few large customers for a significant portion of revenue. If the loss of a single customer can have a significant impact on the company's operations, there is a risk to the shareholders. Investors should therefore ensure that business-facing technology companies have a comprehensive portfolio of customers.

4. Revenue Growth

Another key metric commonly used when analyzing tech stocks is revenue growth. Because many tech stocks are in high-growth industries, quarterly revenue growth levels are closely followed quarter-by-year by Wall Street.

Investors can often get an impression of a company's momentum by looking at the trends with turnover growth levels over several quarters. For example, when year-on-year growth is higher in one quarter than in the previous quarter, the company sees accelerating growth. Conversely, a lower growth rate in the current quarter compared to the previous one means that the company sees a decline in growth.

An accelerating growth rate often indicates a strong headwind or catalyst for business. When investors see this trend, you may want to do more research to see what is behind this momentum. On the other hand, slowing growth rates may indicate that the tailwind or catalyst loses its luster; While slowing growth is not always bad, investors should be aware of why growth is slowing.

Appreciate a technical stock

For the most part, investors should approach valuing technical shares in the same way they would value a stock. A price-to-earnings ratio, or the ratio of the company's stock price to earnings per share, can give investors an impression of how the stock is priced relative to the underlying profit. Similarly, a price-to-book ratio, or the ratio between a share price and its book value per share (assets less liabilities divided by outstanding shares), helps investors understand the premium a company's share price has relative to its underlying book value. Investors can look at these common valuation metrics for a given company and see how they compare to the industry's peers.

But it is a metric that can be especially useful when considering technological stocks: the price-to-sale or the ratio of a company's market value (outstanding shares multiplied by the share price) to total sales. This metric helps investors look at the premium a company trades in relation to sales. A high price-to-sales ratio relative to peers usually suggests that investors believe sales will grow faster than their peers. A lower price-to-sales ratio is therefore usually evidence that the market believes a company's sales will grow slower than its peers.

While the price-to-sales ratio is far from perfect, it is useful when comparing members of one industry to one another. For example, an investor might compare a given company's price-to-sales ratio to the average price-to-sales ratio of shares in that industry.

A price-to-sales ratio is particularly useful for many technology stocks because technical stocks in the same industry can be at dramatically different levels of profitability due to the high operating momentum of some technological stocks. For example, an upstart in fintech with $ 200 million in sales is probably not yet profitable. Meanwhile, a more established fintech company with $ 15 billion in annual revenue can bring in $ 2 billion in profits each year because it has scaled its business enough to make meaningful profits. In this case it would not help to compare the price / earnings figures of the two stocks. However, when looking at price-to-sales ratios, it can prove to be more useful when trying to understand how the market has priced these stocks relative to their underlying businesses.

Opportunities for tech stocks

Two of the biggest opportunities for many tech stocks are the subscription economy and the integration of technologies into new business models.

1. The subscription economy

An interesting opportunity in technology is what is referred to as the "subscription economy." Zuora, a company that is at the heart of this trend as a technology provider that enables companies to switch to subscription-based business models, defines the subscription economy as "the idea that customers are happier to subscribe to the results they want, when they want them , rather than buying a product with the burden of ownership. "

Technological advances make it easier than ever for businesses to offer customers subscription options to access both digital and physical goods.

2. Integration of technologies

Many new technology companies exist because of the close integration and combination of a handful of important technologies. As software becomes more powerful (thanks to innovation and iteration in computing and programming and faster wireless data transfer speed), there are always new ways to implement software to solve problems or create new opportunities. For the shipping industry to exist, for example, it required wireless Internet, mobile payments, GPS (GPS), smartphones and mapping software.

As new and existing technology companies find several ways to combine different technologies, they will be able to improve today's offerings and launch brand new ones.

Risk of tech stocks

Two of the biggest risks for technology companies are regulatory control and foreign production.

1. Regulatory control

Recently, regulatory control of technological stocks has been a headwind for the sector. In particular, data and privacy have seen more control from regulators. This review may present challenges for many technology companies considering how critical transfer and use of customer data is to many of their business models.

2. Overseas manufacturing

Many technology companies produce products or source parts outside the United States to save money on labor costs. Not only does this make companies more dependent on a country with different laws and business practices, but it could be a risk if the US government's trade relations with that country deteriorate. For example, recent trade tensions in the US and China have put pressure on some hardware technology companies that rely on parts from China to find ways to manufacture or buy these parts in the United States.

The top 10 players in technology

With all this background for the tech sector and technology stocks in mind, let's look at some examples of big tech companies. Here are the top 10 US tech stocks based on market capital, as of September 2019:

Company

Market Capitalization

Revenue (TTM)

Net Income (TTM)

1. Microsoft (NASDAQ: MSFT)

$ 1.07 trillion

$ 125.8 billion

$ 39.2 billion

2. Apple (NASDAQ: AAPL)

$ 964 billion

$ 259.0 billion

$ 55.7 billion

3. Amazon.com (NASDAQ: AMZN)

$ 911 billion

$ 252.1 billion

$ 12.1 billion

4. Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL)

$ 841 billion

$ 148.3 billion

$ 34.7 billion

5. Facebook (NASDAQ: FB)

$ 545 billion

$ 62.6 billion

$ 17.1 billion

6. AT&T (NYSE: T)

$ 262 billion

$ 183.5 billion

$ 17.4 billion

7. Verizon Communications (NYSE: VZ)

$ 242 billion

$ 131.1 billion

$ 16.4 billion

8. Intel (NASDAQ: INTC)

$ 222 billion

$ 70.4 billion

$ 19.7 billion

9. Cisco Systems (NASDAQ: CSCO)

$ 207 billion

$ 51.3 billion

$ 13.2 billion

10. Oracle (NYSE: ORCL)

$ 180 billion

$ 39.5 billion

$ 11.1 billion

Data source: Morningstar. Market caps September 5, 2019. TTM = trailing 12 months.

These stocks are likely to be unstable. After all, tech stocks generally see more volatility than stocks in other industries. In addition, they can fall sharply in times of recession or larger sales. But as a group, these stocks are likely to appreciate in value over the next five years or more.

Ready to invest?

As this overview of the tech sector makes clear, the space is home to many exciting companies with heavy winds on their backs. But there are clear risks and concerns for investors to consider.

Investors interested in buying tech stocks should take some time to consider the options. Before investing, be sure to understand the business model of the company you are interested in, the industry and its major risks. In addition, it is worth valuing the stock relative to its underlying fundamentals, such as earnings and sales, and then comparing these metrics to the industry peers. After all, even the biggest companies can be overpaid if they are bought at too high a price compared to the underlying outlook.


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