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

Every day, it seems like we’re being 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 cloud your judgment. So, let’s make like Christina Aguilera and go back to basics.

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

• 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 the best tech stocks into four 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 or Software as a Service (SaaS).
3. Telecommunications: The technology sector making things we use to communicate over great distances, like satellites, telephones, television, and the internet.
4. Information: Companies that provide access to content, marketplaces, and social networks over the internet, such as Yahoo, Alibaba, and LinkedIn.

Each category can cover more than one tech sector, and some technology stocks have integrated across multiple categories in the past few years. The hottest sectors found among these categories include 3D printing, artificial intelligence (AI), blockchain, virtual reality (VR), and cloud computing. 

Eight out of the ten most valuable stocks in the world right now are 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's market capitalization comprises technology stocks, while tech companies are less than a quarter of the S&P 500. Over the past decade, the NASDAQ-100's exposure to the tech sector has helped it outperform the S&P 500 by 2.5x.

Better margins

This applies more to the software tech sector because companies can scale their product to billions of users in the cloud without any manufacturing costs. Overall, though, earnings growth on a balance sheet is the best indicator of whether or not technology companies are making more money.

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 world's largest tech stocks aren’t even 2 decades old. This shows how quickly many tech companies have skyrocketed in value.

Investors refer to the holy quintet of the best tech stocks collectively as FAANG:

Microsoft (MSFT)

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.

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, and 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.

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

This 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 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.

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).
 

Popular tech mutual funds:

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:

Fractional Shares

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

Online investing platforms like Robinhood and even traditional brokerages like Schwab now let you buy fractional shares. Fractional shares enable you to buy a portion of a share in a given stock, so you can invest any dollar amount instead of purchasing 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.

If you'd rather play it safe, that’s a-okay. Technology stocks aren't for everyone, especially investors who can’t handle the volatility or don’t have time on their side—like someone close to retirement. Those with a greater appetite for risk can try their hand at investing in Pre-IPO companies, buying stock in lifestyle brands like FAZE, or building a portfolio of perilous meme stocks.

But if you want steady 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.