Go for Growth: What You Need to Know About Investing in Tech Stocks

Go for Growth: What You Need to Know About Investing in Tech Stocks

Should you just keep it simple and buy Apple stock? Or is there more to it?

Oct 8, 2021

Go for Growth: What You Need to Know About Investing in Tech Stocks
Beginners

Beginners

Stock Trading

Stock Trading

Science & New Tech

Science & New Tech

It seems like every day we’re bombarded with headlines like “Big Tech is becoming the government,” “technology is killing privacy” and the ever-cliché “the tech bubble is about to burst.”

But when you’re brand new to investing in tech stocks, those might only serve to cloud your judgment. So, let’s make like Christina Aguilera and go back to basics.

What are tech stocks, anyway?

Tech stocks are simply shares in companies that sell technology, covering a wide range of business models like:

  • Manufacturing equipment
  • Selling consumer products
  • Charging transaction fees
  • Selling ad space
  • Offering subscriptions services
  • Selling user data

And the list goes on. For the sake of brevity, we can group tech stocks into 4 foundational categories:

  1. Hardware: A catch-all term for physical devices and machines, like light bulbs, airplanes, computers and so on.   
  2. Software: Programs that let us do useful or fun stuff with our devices, like Excel, Chrome and Angry Birds. You used to have to buy a license for each piece of software, but nowadays many companies offer subscriptions, i.e. Software-as-a-Service (SaaS).
  3. Telecommunications: Tech we use to communicate over long distances, like the satellites, telephones, television and the internet.
  4. Information: Companies that provide access to content, marketplaces and social networks over the internet. Examples include Yahoo, Alibaba and LinkedIn.

Within each of these categories, you’ll find some of the hottest sectors today, like 3D printing, artificial intelligence (AI), blockchain, and virtual and augmented reality (VR, AR).

Why investors flock to tech stocks

I mean, eight out of the ten most valuable stocks in the world right now belong to tech companies. And if you still need more convincing, tech stocks tend to offer the following perks.

Higher returns: More than half of the NASDAQ-100 consists of technology companies, while tech is less than a quarter of the S&P 500. Over the past decade, the NASDAQ-100 has outperformed the S&P 500 by 2.5x. 

Better margins: This applies more to software companies, which are able to scale their product to billions of users in the cloud without any manufacturing costs.

Market dominance: Unlike most industries where companies have to fight for a tiny slice of the pie, tech companies are able to build monopolies in their markets. Google, for example, owns 92% of the search engine market. 

Faster growth: Some of the largest tech giants in the world aren’t even 2 decades old. This just goes to show how quickly these companies can skyrocket in value.

Popular tech stocks

There’s a holy quintet of tech stocks that investors refer to as FAANG:

 Facebook (FB)Amazon (AMZN)Apple (AAPL) Netflix (NFLX)Google (GOOGL)
Market Cap$937 billion$1.65 trillion$2.34 trillion$228 billion$1.83 trillion
Returns (YTD)23.65% 2.27% 9.33%22.12%59.19% 

Side note: I’m pretty sure Microsoft was swapped out for Netflix just to make the acronym sound cooler. 

Microsoft (NASDAQ:MSFT)

  • Market cap: $2.2 trillion
  • Returns (YTD): 34.36% 

Aside from the overall benefits of investing in tech, these particular stocks are popular buys because:

  • They’re market leaders that still have growth potential.
  • They’ve been able to remain profitable in good times and bad. For instance, the demand for many of these products has only grown stronger during the global pandemic.
  • They’re less vulnerable to price swings because of their huge market capitalizations.

When tech stocks blow up in your face

Beware: Tech’s high growth potential doesn’t come without a price. Aside from stock market bubbles like the dot-com crash, tech stocks are risky for the following reasons.

Difficult to understand: Laymen aren’t always able to pinpoint the value of these products or services. And if that’s the case, why should you expect the price to go up? And “because Wallstreetbets said so” is not an answer.

Hard to maintain competitive advantages: As quickly as new tech giants rise, old tech giants fall, a la BlackBerry, Kodak, Yahoo. 

New tech might not go mainstream: This one applies more to startup investing, whose shiny new gadgets might be too ahead of their time or worse: not even needed by customers. 

Higher volatility: Depending on your risk profile, you might not be able to stomach your investments dropping 12% on a bad day, which is exactly what happened to tech stocks in March 2020.

Regulatory changes: More and more, regulators are beginning to go after tech companies for issues like monopolization, data privacy and pollution.

Picking tech stocks isn’t rocket science

When you’re considering investing in a tech stock, you should evaluate it like you would any other business by asking if it has:

  • A great product that customers can’t live without
  • Competitive advantages like intellectual property or high switching costs
  • A hard-working team that is quick to adapt

Beyond the fundamentals, you can also analyze the technical factors below.

Revenue growth: See if a company has momentum by looking at its revenue growth over multiple quarters. This metric is especially suited for young companies that aren’t profitable yet. If every quarter is higher than the last, you might want to hop on board that accelerating vehicle.

Gross profit margin: The difference between revenue and the cost of making a product, divided by the revenue. The higher this number, the more money the company can ultimately make.

Operating leverage: Operating leverage tells you whether a company’s revenue can keep growing even after it covers its costs. High operating leverage means that a company is scalable.

Price-to-earnings (P/E) ratio: This metric gives you an idea of how much the market expects a mature tech company to perform. A high P/E ratio could either mean that a company is overvalued, or that investors expect significant growth in the future.

How to buy tech stocks on the cheap

The straightforward way to invest in a tech stock is to buy shares with a broker or trading app. But you can get the most bang for your buck and also diversify your investments with:

  • Tech mutual funds
  • Tech ETFs
  • Fractional shares

Let’s explore each option.

Tech mutual funds

A tech mutual fund pools together money from many investors to buy a diversified basket of individual stocks. Tech mutual funds are run by a professional money manager or firm that invests according to a theme (e.g. Aerospace) or objective (e.g. capital gains). They have an expense ratio (typically ranging from 1% to 3%), which is an annual membership fee that’s deducted from your returns. You'll be required to make a minimum initial investment, and these minimums usually start at $2,000. The mutual fund pays out through stock dividends and capital gains distributions.

Popular tech mutual funds:

 BlackRock Technology Opportunities Fund (BGSAX)Fidelity® Select IT Services Portfolio (FBSOX)Goldman Sachs Technology Opps Fd (GITAX)
Returns (1 Yr)0.40%0.33%0.35%
Expense Ratio1.18%0.72%1.27%
Assets Under Management$9.10 billion$4.42 billion$918.03 million

Tech ETFs

Like a mutual fund, a tech ETF also offers a basket of stocks. But most ETFs are passively managed and track a specific stock market index. The advantage of ETFs is they usually have lower expense ratios than mutual funds and don’t require a minimum investment.

Popular Tech ETFs:

 NASDAQ-100-Tech Sector ETF (QTEC)iShares Expanded Tech Sector ETF (IGM)Vanguard Information Technology ETF (VGT)
Returns (1 Yr)0.33%0.30%0.30%
Expense Ratio0.40%0.48%0.09%
Assets Under Management$3.68 billion$3.68 billion$48.91 billion

Fractional Shares

You might think that the major tech stocks are too expensive. Amazon stock, for instance, trades above $3,200 on most days. But who says you have to buy the full share?

Many robo-advisors, like Robinhood and SoFi, and even more traditional online brokerages like Schwab, now let you buy fractional shares. Buying fractional shares lets you buy a portion of one share in any given stock, so you can invest any dollar amount instead of having to purchase whole shares. This means you can own blue-chip stocks that were previously out of your price range. It also helps you diversify your portfolio at a lower cost since you don’t have to buy full shares of each stock.

sofi

SoFi

4.5

Robo Advisor

If you'd rather play it safe, that’s a-okay. Tech isn’t for everyone, especially investors who can’t handle the volatility or don’t have a lot of time on their side—like someone close to retirement. But if you want growth, are willing to play the long game and won’t panic sell when the market dips, you’ve got the makings of a successful tech investor.

True or False:

Single stock investing is more expensive than investing in funds because of the fees and taxes associated with buying and selling single stocks.

True or False:

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