With the rise of Silicon Valley and the rapid growth of the tech industry, even armchair investors are paying close attention to tech stocks.
Last year, the technology sector had a level of deal activity “not seen since the dot com era,” said Rob Fisher, PricewaterhouseCoopers’ (PwC) U.S. technology deals leader, in a February 2015 press release.
According to the press release, which covered PwC’s U.S. Technology Deals Insights 2014 Year in Review and 2015 Outlook report, “In total, there were 60 technology IPOs, an increase over the 51 posted in 2013, making 2014 the most active year since 2000.” The company added that this momentum is expected to continue into 2015.
With that kind of escalating buzz, it would seem like a no-brainer to invest in tech stocks from day one—but buying these stocks isn’t necessarily easy money. There’s a lot of hype surrounding tech companies, especially as they go public, investors say.
Justin Klein, executive vice president at Dana Point, Calif.-based investment advisory firm KPP Financial and co-host of InvestTalk, a free educational podcast on finance and investing, says it’s generally wise for average investors to steer clear of the IPO bandwagon.
“Day one is the worst time to invest,” Klein says. “During the IPO, the owners are selling at an advantageous price to them, not you.”
Tech stocks tend to bring out investors’ worst instincts because they are often the “hot stocks”—more volatile, more in the news, and “sexier” than stocks in other industries, says James Shen, senior research analyst for Altair Advisers LLC, a Chicago-based investment advisory firm. For that reason, these stocks tend to be more irrationally priced, he says.
What to consider before investing in tech stocks
To get a better understanding of these stocks, Shen says, “long-term investors should evaluate tech stocks the same way they do any stock—based on earnings, revenue, growth potential, and competitive advantages.”
As a general rule of thumb, Klein says, investors can consider whether a particular company has a sustainable long-term business model that is evolving and adapting with the latest technologies.
Investors also may want to look into whether a company has products that can stand the test of time as well as a strategy for growth. Some companies are hot at the beginning because they offer a novel concept, but they wind up getting undercut by competitors, Klein says. Instead, investors should focus on companies that have a proven track record of pushing into new and innovative territories.
As a long-term investment strategy, new investors may also want to consider blue-chip tech stocks, or stocks from large, established companies with relatively stable earnings, such as Apple and Google. Analysts also say investors may be able to minimize their risks by keeping a diversified portfolio and putting money in less volatile non-tech stocks as well.
Klein says investors evaluating a tech company can start by looking at how much money the company is making and determining both its cash flow and its prospects of earning money over the long term. He also recommends that potential investors review the company’s leadership profile, noting that a company with unstable leadership and high turnover of executives is potentially a red flag.
If you are interested in taking your research one step further, try to home in on a stock’s intrinsic value, Klein says, as opposed to the value at which it is being traded in the marketplace. However, keep in mind that this is a complicated calculation that even seasoned investors and analysts belabor. For help with this or with other questions or concerns, you may wish to consult with a seasoned professional, such as registered investment advisor or a capital management agency, particularly if you have a specific stock in mind or want to explore the methodology behind different ways to calculate intrinsic value.