3 Factors to Consider in Tech Investing

William is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

With Microsoft (NASDAQ: MSFT) and Intel (NASDAQ: INTC) scrambling to redefine themselves in this new tablet and mobile world dominated by companies like Apple (NASDAQ: AAPL), you have to wonder if tech stocks are too risky. Don’t get me wrong, innovation provides the lifeblood of progress in society and investors can benefit greatly if they invest in these types of businesses; however, in order to capitalize on technology stocks a successful investor needs to be mindful of 3 factors.

The Next big thing

A tech investor always needs to look out for the “next big thing.” Obsolescence can occur overnight or slowly over a period of years. For example, the Microsoft Windows operating system dominated the technological landscape for years. Nearly all personal computers sold in the 80s and 90s had a Microsoft operating system installed on it.

Then, in late 2001 Apple introduced the world to the iPod, a popular device that didn’t need Windows to operate. A number of people, including yours truly, actually thought the iPod would bomb and sink Apple altogether, but instead it exploded in popularity. Later, Apple came out with the iPhone and eventually the iPad thus revolutionizing personal computing all without the aid of Microsoft Windows.

Some of the highflying PC manufacturers of the 1990s were acquired or disappeared altogether. The remaining PC manufacturers continue to struggle.

Dell (NASDAQ: DELL) reported an 11% decline in its revenue for the most recent quarter. All segments declined except for the Enterprise Solutions and Services and the Server and Networking segments.

Hewlett Packard (NYSE: HPQ) reported a 7% decline in its revenue for the most recent quarter. Hewlett Packard only experienced growth in its Software and Financial Services segment.

This highlights the unpredictability of tech trends. Even as of this writing, rumors persist of a possible deal between Apple and Intel to include Intel chips in the next generation of iPads. The choppy relationship between Apple and Samsung as well as Apple’s struggle to meet increasing demand leaves some pundits under the impression that Apple will turn toward Intel to meet a shortfall in chip capacity.

The Competition

Success from an innovative tech product invites many competitors who can eat into a company’s profit margins and subsequent investment returns. The most recent examples include all the tablets introduced to the market in response to the Apple iPad such as the Google Nexus, Amazon Kindle, and Microsoft Surface. Even though the Apple iPad currently rules the tablet market with 63% of all tablets shipped; another product could eventually take the lead; alert tech investors need to be ready to respond accordingly.

The Risk Factor

What I am about to say take with extreme caution: Sometimes successful tech investing simply means assuming market risk. From 1990 - 2002 (see the chart below) Microsoft gave its investors a total return of 5,100% versus an S&P 500 total return of 362% all the while its P/E ratio expanded 143%. A value investor with concerns about that high P/E ratio (cough, cough someone like me) would likely have missed out on those gains.

However, I urge caution. Near the end of the 1990s Microsoft’s P/E skyrocketed toward 80, high even for a growth stock, before crashing from a peak not seen since. While partaking in possible superior gains an investor may have to pay a premium. However, paying an astronomical price can prove disastrous for your portfolio during a severe market correction.

<img src="http://media.ycharts.com/charts/51ea7efd6cb9b26b2026c0b6c7fe16ab.png" />

MSFT Total Return Price data by YCharts

Conclusion

Tech investing involves a great deal of extra uncertainty. The timing and innovation of the next big thing means extra alertness to new products that can turn a piece of hot technology into yesterday’s news. Competition can eat into your company’s margins, profitability and subsequent stock market returns. Successful tech investing can involve the assumption of market risk with the full realization that the market could crash at any moment. The enterprising investor can profit a great deal from investing in tech but the timid should stay clear.


stockdissector has positions in Apple and Microsoft mentioned above. The Motley Fool owns shares of Apple, Intel, and Microsoft. Motley Fool newsletter services recommend Apple, Intel, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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