Technology companies are generally very popular with investors because they bring innovations that offer great growth prospects, both in revenues and profits. However, the sector has also been the source of major stock market crashes, such as the ".com" bubble in the 2000s. Café de la Bourse gives you 5 criteria to make a good investment in technology companies on the stock market and thus maximize your earning potential.
WHAT INNOVATION AND VALUE PROPOSITION DOES THE TECHNOLOGY BRING?
Technology can be defined as science or knowledge applied to solve problems or invent useful tools. A primitive example: the first knife in the Stone Age, which made it possible to cut meat better and thus improve human nutrition.
More recently, the Internet has developed and is now omnipresent in our society to access information (like this article you are reading). The development of new technologies is accelerating and it is certain that some of them will revolutionize the societal landscape in the coming years. There are many candidates: artificial intelligence, blockchain, augmented reality, IoT, biotechnology, etc. There are many opportunities to invest in technology!
However, it is important to understand what value proposition this technology brings to its market: technology should be a means to create value, not a goal in itself. So, when considering a technology company for a potential investment, ask yourself the following questions. What is the company actually selling? Who is interested in this offering? What is the added value of this offering to those interested? Once you have answered these questions, you can move on to the next step: understanding the business model.
UNDERSTANDING THE BUSINESS MODEL: HOW DOES THE COMPANY MAKE MONEY?
Once you have identified the value proposition, you need to understand how the business model works, i.e. Answer the question: how to make money on business?
This question seems trivial, but it has become much more complex with technology companies: there are now many different models and companies sometimes use several of them. This is especially true in software (freemium, subscriptions, monetization through advertising, etc.). In addition, many technology companies focus their strategy on hyper-growth (rapid capture of market share) without first focusing on profit generation, which can leave investors unclear about their real ability to create value over the long term.
Companies such as McPhy Energy (hydrogen technology) or Uber (VTC Internet services) have not yet generated profits and end up correcting on the stock market because of investors' uncertainty about their ability to generate profits. It is important to understand how the company will create value now and/or in the future from an investment perspective.
STUDY THE GROWTH DYNAMIC: REVENUES, PROFITS, AND INVESTMENTS
After studying the company's value proposition and business model, you can look at three financial fundamentals characteristic of a virtuous growth company.
First, of course, look at revenue growth. It must be significant from the moment the product or service is launched to reflect the strong value proposition and the commercial capture of that value. This growth should also ideally accelerate, especially if the company's maturity is low.
On the other hand, you'll need to pay attention to profits. Is the company able to generate this revenue while maintaining a sustainable level of expenses? Are the profits growth over the last few years? To answer these questions, you can, for example, look at operating and net margins and their growth over the last five years.
Finally, look at the amount of investment. For some companies, especially in the software industry, it is important to look at the amount of R&D (research and development) and make sure that it is high (~30% of costs), that it remains stable, or even increases over the years. For other companies, more industrial, it is about looking at the amount of CAPEX in the cash flow statement. This amount must be high, stable or growing, to ensure that the company continues to invest in its technological assets. A good level of investment is a good indicator of growth prospects.
THE MARKET: WHAT SIZE? HOW MATURE IS THE TECHNOLOGY?
It is important to look at the technology company's market from two perspectives: the size of the addressable market and the maturity of the market. The addressable market is simply the sum of all possible sales of the company to all its potential customers. We want this market to be large enough for the company to ensure its long-term survival, even with increased competition.
Next, we must look at the company's market share in this addressable market. The company must have enough market share to demonstrate credibility but enough room to grow further. Consider that a mature company typically has 10-20% of its market share.
Finally, let's remember that there is a very important criterion for technology companies: the maturity of the market relative to the technology. Do the offerings already exist? Do customers know that the technology can provide value or do they need to be educated? Does the technology have the capacity for large-scale deployment? Technology like a blockchain, for example, is still at a low level of maturity, while the cloud has reached a higher level of maturity.
MIXING TWO STRATEGIES: STOCK PICKING AND ETFS
Our last piece of advice is about investment strategy. It is important to diversify your investments in the stock market and even more so when it comes to technology companies. Even if you choose companies respecting the criteria presented above, technology companies remain a high-potential investment and therefore a fortiori a high-risk one.
To try to diversify your portfolio, you can apply the following strategy: on the one hand, select companies with very high potential to try to invest in the next nugget; on the other hand, invest in trackers composed of companies from various sectors and different levels of maturity such as ETFs on the Nasdaq or on North American technology stocks. In addition, there are also thematic ETFs based on certain technologies if you want to gain exposure to a particular technology, such as the Global X BOTZ ETF on AI and robotics.
All our information is, by nature, generic. It does not take into account your personal situation and does not constitute in any way a personalized recommendation for the realization of transactions and cannot be considered as financial investment advice, nor as an incentive to buy or sell financial instruments. The reader is solely responsible for the use of the information provided, without any recourse against the publishing company of Cafedelabourse.com being possible. The publishing company of Cafedelabourse.com cannot be held responsible for any error, omission, or inappropriate investment.
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