Technological innovation has simplified just about everything these days. Going to a brick-and-mortar store to shop around for great deals is a thing of the past, and if you have a question you can’t answer, all you need to do is Google it. From medicine to communication, food, education, and entertainment, technology has made incredible improvements in our lives.
It’s not surprising that technology companies are some of the most highly valued companies in the world today. In fact, according to FXCM, the five largest companies listed on the stock market today are all technology companies.
It’s no wonder investors are piling into tech stocks in an attempt to join in some of the tremendous gains seen in the sector in recent years.
How to Invest in Tech Stocks
With the excitement that surrounds the tech sector and technology companies being some of the biggest in the world, it’s not surprising that investors continue to pile into the space.
However, not all tech stocks will be profitable investment opportunities. In fact, the wrong moves in the tech sector can lead to significant losses.
So how exactly can you go about investing in the best tech stocks?
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1. Invest in Nasdaq Index Funds
One great way for investors to gain exposure to the technology sector is to invest in Nasdaq index funds. These funds are developed to provide broad exposure to all assets listed on the Nasdaq stock exchange, offering strong diversification in the search for tech stock profits.
The Nasdaq is a tech investment because it is the most tech-heavy index on the stock market today. There are some options for tech investors who want to buy Nasdaq index funds:
- Nasdaq Composite Index Funds. Nasdaq composite index funds give investors exposure to the 2,500 companies listed on the Nasdaq. Although the index is tech heavy, not all companies listed are tech companies. Nonetheless, many investors enjoy the heavy diversification offered by the Nasdaq composite index, providing relatively safe exposure to the tech sector.
- Nasdaq 100 Index Funds. The Nasdaq 100 index is composed of the 100 largest and most actively traded stocks on the Nasdaq stock exchange. Because most of the 100 largest companies listed on the Nasdaq stock exchange are tech companies, an investment in Nasdaq 100 index funds is a diversified investment in the tech sector as a whole, but more focused on the large-cap tech giants.
2. Invest in Tech-Focused ETFs and Mutual Funds
There are several ETFs and mutual funds on the market today that are designed to give investors exposure to the tech sector in a relatively low-risk way. Some of the most popular tech-focused ETFs and mutual funds include:
- Technology Select Sector SPDR Fund (XLK).
- iShares Expanded Tech Sector ETF (IGM).
- Vanguard Information Technology Index Fund (VGT).
3. Look Into the Tech Giants
If you want to invest in the tech sector but would like to choose single-stock investments rather than investing in ETFs and mutual funds, a great way to start is by looking into the tech giants.
You know these companies by name. These big tech stocks represent companies that have been so successful that they’ve become household names.
Big tech stocks represent a subsector of the tech space that garners more attention than just about any other corner of the stock market today. Some names in big tech include Facebook, Amazon.com, Apple, and Alphabet (Google).
Although any company — no matter how big or small — can fail, big tech companies have a long history of solid performance, which is what allowed them to grow to become what they are today.
These companies are known for generating compelling revenues and earnings while staying at the forefront of their respective industries. As a result, they haven’t only become household names, they’ve become some of the biggest names on Wall Street today.
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4. Consider Smaller Technology Companies on the Leading Edge of Innovation
It seems like new technologies are developed every day. Pretty soon, the average car will drive itself and run on clean fuels, rechargeable batteries, or another form of clean energy. New medical treatments will be developed. Who knows the innovation that’s going to take place in just about any other facet of life?
The companies that develop technologies that change the world tend to be incredible investment opportunities. Just look at Microsoft. In the beginning, many believed home computers would never take off. They were expensive and people had no real need for them.
Today, computers are involved in almost every aspect of the average American’s day-to-day life. At the same time, Microsoft is one of the largest companies in the world with a market cap of more than $1.5 trillion.
Who knows what the next life-changing technology will be? One thing that’s known for sure is that technological innovation is going to continue, and investors who get in on the ground floor of these opportunities have the potential to become millionaires in the process.
Of course, there is a downside. The higher the potential reward, the higher the risk. Those companies currently developing the next big thing may never be successful. For every smash hit product, there were a thousand that didn’t make it. So, if you’re going to invest in highly speculative emerging technology stocks, it’s important that you have a knack for knowing what’s hot and what’s not and that you do detailed research to understand the risks.
5. Invest in the Technology of the Future
The world is changing right in front of you. Artificial intelligence gives you a way to communicate with your house, your computer stores everything in the cloud, and you keep hearing about a digital currency called Bitcoin that’s worth five figures.
What’s the world coming to?
It’s moving toward a more efficient economy. For this economic efficiency revolution to take place, there will need to be further advancements in three key technologies:
- Cloud Computing. Cloud computing is a technology that makes computer technologies, like data storage and computing power, available on an on-demand basis. Users tap into resources on the Internet, or “in the cloud,” rather than having to own and manage these systems firsthand. This gives the average person access to the fastest computing capabilities and the highest storage capacities possible at a relatively inexpensive cost.
- Artificial Intelligence. Artificial intelligence is being deployed in various areas of business around the world. It’s driving everything from medical diagnoses to digital advertising, online trading activities, and logistics.
- Blockchain Technology. The blockchain is a self-regulated system of contracts. These contracts are used to form some of the world’s most popular cryptocurrencies. Although cryptocurrency itself is a speculative investment, the blockchain is solid technology. It stands to change the way transactions happen, both in monetary exchanges and the transaction of data from one party to the next.
No matter what the next big change is, it will likely involve one or more of the technologies listed above. By investing in these emerging technologies early, you’ll have the opportunity to tap into potentially life-changing returns.
What to Look for in Technology Stocks
As is the case in any sector, not all technology stocks are created equal. Some will represent incredible investment opportunities while others will lead to significant losses. Before making an investment in any technology stock, there are a few things that an investor should look for:
1. Innovative Technologies
The tech sector is constantly evolving, and if a company in the sector doesn’t stay at the forefront of the evolution, they’ll be left behind.
Just take a look at BlackBerry. Several years ago, BlackBerry devices were the hot item. It took the power of your home computer — at least some of that power — and put it in the palm of your hand. Every businessperson, doctor, student, and trendy consumer had or wanted a BlackBerry smartphone.
As competition started to come into the market, BlackBerry got too comfortable with its leadership position, falling behind in innovation. As a result, BlackBerry lost market share and started a downward run in the market that would last for years. Today, BlackBerry is still alive, largely as a software company, but it’s nowhere near as valuable as it once was.
On the other hand, Apple, the leader of smartphone innovation is now the king of the industry and one of the largest companies in the world.
Before making an investment in a tech stock, make sure that the company represented by the stock is actively innovating.
2. Strong Balance Sheets
Technology is a cyclical sector. When economic conditions are positive, consumers are willing to spend money on cutting-edge technologies. When economic conditions are negative, consumer spending slows and tech companies tend to struggle.
As a result, it’s important that any tech company you invest in has a strong balance sheet with plenty of cash to get through the hard times.
At the same time, being successful and maintaining that success in the tech sector is all about innovation, which, in corporate terms, relates to research and development (R&D) expenses. Tech companies that don’t have enough money in the bank for R&D expenses will eventually fall behind other companies in the space.
3. Consumer Adoption
New technologies are a great place to generate momentous gains. However, it’s important that whatever the new technology is has consumer interest. After all, if nobody’s buying the company’s products, it will never make it to profitability.
Just take a look at GoPro.
The company has compelling technologies. Its extreme action cameras can take a beating, film underwater, and be connected to sports helmets to capture all the action. It’s like a match made in heaven, combining the sports enthusiast with the videographer.
When GoPro cameras were first released, everyone thought that consumers would jump on the opportunity to own one. Unfortunately that wasn’t the case. Although sports enthusiasts were in love, the average consumer had no interest in an extreme action camera.
As a result, the company has operated at a loss for several years, having to tap capital markets multiple times to stay afloat and losing more than half of its value over the past five years.
The bottom line is that having great technology isn’t enough. In order for tech companies to do well, they have to have a product that appeals to the masses. Look for companies with a track record of growing sales that prove consumers are eagerly adopting their technologies.
Competition is a harsh reality in the tech space. Any time a new technology does well, it seems like every company in the sector jumps on the opportunity to take share in the emerging market surrounding the product.
Those that do best in the tech sector stay ahead of the competition by either carving their own niche with new technologies and continuing to innovate to stay on the top, as is the case with Microsoft, or by fundamentally improving existing technologies to take the market by storm, as was seen when Apple took the smartphone industry from BlackBerry.
Before investing in any tech stock, make sure that the company has what it takes to take or maintain the position as leader in its respective area of technology. If that’s not the case, an investment in the stock may lead to significant losses.
The renowned investor Warren Buffett often uses the term “economic moat.” Just as a moat surrounding a castle protects the castle from intruders, an economic moat protects a company’s value from competitors. There are two fundamental building blocks to a strong economic moat:
- A Market-Leading Product. The product being sold by the company should be so innovative that it’s hard for other companies to compete with the offering.
- Intellectual Property Protection. To keep competitors at bay, savvy tech companies have a strong intellectual property portfolio. This portfolio will consist of patents, trademarks, and copyrights surrounding each product sold. Just having the intellectual property isn’t enough either — the best investments are companies that have already proven the strength of their IP portfolio in court.
Before risking your hard-earned dollars on any tech stock, make sure the company has an economic moat that’s strong enough to stave off competition.
Mistakes to Avoid in the Tech Sector
Knowing what to look for in a quality tech stock is a major part of successful tech sector investments. Another major part is knowing what to avoid. Here are a few costly mistakes that you should work to avoid when investing in tech.
Investing in Companies With Nothing
There are several small companies on the stock market that say they have great technologies in the works, but they’re still in the research and development stage. At this stage, there’s no telling how long the company’s technology will take to make it to market, or if commercialization will ever even take place.
Investing in companies that don’t have a product on the market yet is risky business. Sure, many have been successful in doing so — even Bill Gates needed startup funding. However, it’s safer to look for companies that already have products on the market and are generating revenue through the sales of those products.
Paying High Valuations
The tech sector has some of the highest valuations seen on Wall Street. Unfortunately, you’ll have to be willing to pay a higher valuation in this sector than in energy, health care, or just about anywhere else.
For the most part, the high valuations are justified. Maintaining a position as the king of any hill in tech will lead to incredible profits.
However, due to the high interest in the tech sector as a whole, investors often push valuations to unrealistic highs. Keep in mind the average valuation metrics below and try to stay as close to those valuations as possible when making investments in tech stocks:
- P/E Ratio. The average price-to-earnings (P/E) ratio in the tech sector is around 50.
- P/B Ratio. The average price-to-book-value (P/B) ratio in the tech sector is about 14.
- P/S Ratio. The average price-to-sales (P/S) ratio in the tech sector is about 10.
By doing your research and making sure that any tech company you invest in has valuation metrics that come in lower than the industry average, you’ll ensure that you’re not paying too much for your shares.
Investing in Companies With Small Target Markets
Technology is great, but it costs quite a bit of money to develop new technologies. In order to turn a profit from this investment, it’s important that tech companies are able to sell their products to a mass market.
Time and time again, new technologies are created that seem as though they’ll take the market by storm, only to find that when they do reach the public, the target audience is too small.
GoPro was a perfect example of this conundrum, but they aren’t the only company to suffer a similar fate. It happens across all areas of tech. For example, biotech company MannKind Corporation (MNKD) created a product known as Afrezza, an insulin with a unique technology that allows it to be inhaled rather than injected. The investing community predicted that Afrezza would take the market by storm, driving up share prices. Unfortunately, the insulin proved to be appealing only to a small audience, leading to share prices losing more than 60% of their value since March of 2016.
Investing in Companies With Little Money in the Bank
The tech sector is an expensive one to operate in. Not only are there high research and development costs, companies often have to cover the high cost of marketing to consumers or businesses in order to take their piece of the pie.
When choosing tech stocks to invest in, it’s important to find companies that have plenty of money in the bank and that are consistently adding more cash flow to the stash. Should funding dry up, shareholders will pay the price as the company’s stock price falls.
The tech sector is an attractive one for two big reasons. Not only is technology a massive industry that’s known for generating compelling gains, it’s also interesting to consumers and investors alike.
Investing is all about research, and researching crude oil or some other sector that lacks an excitement factor can be a tiring process. However, there’s something inherently intriguing about researching the latest and greatest in tech that promises to change the world.
If you’re going to invest in the sector, it’s important to keep in mind that not all tech companies will be a success. Take the time to do your research and get a strong understanding of the risks and rewards that your investment may lead to before ever investing your first dollar.