Technology Sector: Investment of a lifetime?

Tech has been at the center of a lot of talk over the past few decades, investment related or not. Is the Technology sector a good investment? The following article is meant to outline the Tech sector and evaluate its potential-Sit back and enjoy TRADEPRO’s.

Technology Sector: Basics

What is the tech sector? Said simply its a financial instrument sector made up of stocks based on the tech industry, whether its tech goods or services. Some of the bigger tech names you might know, reside in the FAANG index, Facebook, Amazon, Alphabet, Netflix, and Google. It’s no surprise that a lot of investors and traders alike have experienced substantial gains from the tech sector over the past decade. Just take a look at the S&P 500 vs the tech-heavy Nasdaq.

Since 2009, Nasdaq which a tech heavy index has risen approximately two times more than the S&P 500. Which can be interpreted as a more volatile index as well.

Trading View-Nasdaq vs S&P 500

Anything that you can think of that revolves around information technology is represented in the tech sector. Consumer goods like T.Vs. computers and your beloved iPhone are all represented in the tech sector. It doesn’t start and end there however, the tech sector is booming with software development that is used by companies in every industry. From managing payment systems to logistics.

Tech powers our trading stations and our algorithms, if you have them.

Technology Sector: Investing

Tech has been the source of the bubble at the turn of the millennium but its also a thriving and growing sector as of late. Companies in the tech sector have been great investments for a lot of people as most tech sector power houses are publicly traded. You can own Apple shares, or better yet tech sector ETF’s that give you a taste of a tech basket of goods for a fraction of the price. For more information on tech ETF’s, click here.

How good of an investment is the tech sector? That’s what were here to find out today. For one, innovation is key to a tech companies survival. A long term investment would be best held in a company that can adapt with the times or continue to grow with its competition.

Most notably, the tech sector names have outrageously high P/E ratios, which is normal… to an extent. Ideally, you would want your investment to have high earnings, but that may not be the case for many companies in the tech sector. The estimated average P/E in the tech sector in 2018 was 22.15. As a comparison tool, GOOGL has a P/E of 25.27, and Microsoft has a P/E of 25.38 while AMD has a P/E of 74.75.
Is the P/E a viable ratio to use when evaluating tech stocks for your portfolio? In short, no!

There is a simple reason for this, assets developed by tech companies are usually created in-house and are not reflected in the balance sheet. Meaning that net income will be close to zero or even negative because all salary expenses are reflected towards net income. So if earnings are zero or negative, then the P/E is useless when evaluating tech stocks.

Technology Sector: Finding the best long term investment

One way of evaluating a tech company for an investment opportunity is being a techie! Meaning someone who is obsessed with tech and all things related to a company’s innovation. However this is probably not the case for many of you out there.

Its no secret that it is hard to find an early stage tech company who is worth the investment, who knows where they’ll be in months let alone years. Take Blackberry and Apple for example. Before Apple strolled along, Blackberry was a leader in the smart phone industry… now look at them.

For the non-techies, there are two fundamentals to consider, other than innovation and ability to do so. Revenue and margin growth.

Tech Revenue

Revenue is a big proponent to a sustainable company and tech is notorious for over promising and under delivering. How many times have you heard a company’s new piece of software or hardware is the next big thing that will replace so and so? A few months even years later, nothing gets delivered, *Tesla*. Well that’s what you should avoid when investing in tech, innovation without proof.

A good tech investment is one that has revenue growth and at a high rate. A revenue growth rate of 15% and more is considered good. Meaning whatever they have to offer is in high demand. This can be considered proof of their innovation!

Using AMD as an example, revenue growth in 2016, 2017, and 2018 was 8.22%, 21.63% and 23.26% respectively. There is a near 1000% growth from 2016 to 2018 in AMD stock, up $19.00 from $2.00. The extensive growth in revenue was a key qualifier for the longer term investment in the company.

AMD Chart-Trading View

AMD has been a leading producer of processors, graphics and tech. Which has been on the rise over the past three years.

Tech Margin

A growing operating margin goes hand in hand with increased revenue. It’s one thing for a company to continue to make money year after year but its another to hold pricing power, which is what operating margin represents. It is a company’s operating income divided by total revenue. Preferably this number should increase quarter after quarter with revenue growth. It measures the return on sales.

If you take Kodak as an example, who was growing revenue like crazy selling digital cameras. However, in 2001 the company was suffering from digital sales, losing $60 a camera sold.

Take AMD operating margin, although it is not something to marvel at quite yet, it does increase quarter after quarter. From Dec 17, Mar 18, Jun 18, Sep 18, operating margin was 5.54%, 7.29%, 8.71% and 9.07% respectively. Although the operating margin is not a large percentage, it is important to notice it increases with revenue growth. This makes AMD a viable investment based on the two criteria listed.

Final thoughts

As an investor, if you know the tech industry in and out, focusing on the development of the industry and company innovation should not be a problem when deciding on what company to invest in. However, for those who are not as interested in the tech industry’s inner and outer workings. The oversimplified fundamental analysis listed here should give you a solid starting point in investing in the industry.

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The information contained in this post is solely for educational purposes, and does not constitute investment advice. The risk of trading in securities markets can be substantial. You should carefully consider if engaging in such activity is suitable to your own financial situation. TRADEPRO Academy is not responsible for any liabilities arising as a result of your market involvement or individual trade activities.