At this point, it's nearly become a cliché. Your friend's aunt invested in Apple® shares years ago and now lives on a boat full-time. Your relative knows someone who knows someone who acquired Microsoft shares in the 1980s for a few bucks a share and is now a millionaire.
These are essentially urban legends. However, if you're trying to purchase your first technology stock or diversify your portfolio, you may discover that reality differs from fiction. There are several stock kinds, each with its own performance patterns, advantages, and disadvantages. Here are a few critical facts to understand about investing in technology companies.
Why Are Investors Putting Their Money Into Technology?
Much of the stock market's recent growth has been focused on shares of technology businesses. As of late September 2020, the S&P 500's top five most valued corporations were over 10% more valuable than the index's 300 smallest companies.
Apple, Amazon, Alphabet (parent company of Google), Microsoft, plus Facebook each have a market capitalization of well over $1 trillion and are together worth more than $7 trillion.
All of these enterprises performed well in 2020, despite the financial turbulence brought about by the COVID-19 epidemic and the resulting disruptions in how people work, shop, and live. Wherever these equities move, the broader stock market indices tend to follow, since they account for around one-fifth of the S&P 500.
- Apple (AAPL). Market Cap: $2.1 trillion. P/E ratio: 36.84
- Alphabet (GOOGL). Market Cap: $1.06 trillion. P/E ratio: 35.36
- Amazon (AMZN). Market Cap: $1.68 trillion. P/E ratio: 129.29
- Facebook (FB). Market Cap: $774.36 billion. P/E ratio: 34.68
- Microsoft (MSFT). Market Cap: $1.67 trillion. P/E ratio: 38.32
Technology firms, particularly those that sell software, are often regarded as the most stable types of enterprises, given their goods are virtually free to replicate but may be fairly costly to purchase. Apple, for example, prices iPhones competitively, sells a large number of them, and then maintains an ecosystem of applications and services that generates consistent income. Amazon's success is linked to its operational efficiency and affordable costs. Alphabet and Facebook are able to sell more advertisements due to the sheer size of their networks and the popularity of their services.
Things To Consider Before Investing in a Technology Stock
When it comes to investing in general, it's critical to do a thorough analysis of the stocks you're considering.
Technology businesses, in particular, can have relatively high price-to-earnings ratios, which makes the company's profits seem little in comparison to the share price. This is often the case because investors anticipate fast future development.
Other critical ratios include price-to-sales, which compares a company's stock price to its revenue. That's something to contemplate in the event of a rapidly developing business that has not yet generated significant earnings.
Another critical thing to consider is the company's total sales growth rate—how quickly revenue climbs year over year or even quarter over quarter.
A more specific indicator that might be beneficial for technology businesses is "gross margins," which are calculated as the difference between revenue or sales and the cost of making those sales, divided by total revenue. The resultant percentage shows whether or not the business can profit from the goods it offers and how much profit it can earn. If the company's other expenditures can be reduced as a proportion of overall sales, profits may increase more rapidly.
The Advantages of Including Technology Stocks
There is plenty to be argued about investing in technology equities, whether one is diversifying or purchasing anything other than an exchange-traded fund (ETF) or an IRA. With the advent of artificial intelligence (AI) with machine learning (ML), there may still be a lot more world to alter out there. These are some of the potential advantages of including technology equities in a portfolio.
Numerous blue-chip technology businesses exist. The name "blue chip" originates in the game of poker, where blue chips are the most valuable. Blue-chip stocks are often those of well-established corporations with a track record of producing high returns. The blue chips of today include massive technology businesses such as Facebook, Alphabet (Google), as well as Amazon.
Certain technology stocks pay dividends. Dividend-paying companies may have a number of advantages, including stable profitability, and they may suggest that the firm is well-positioned to generate great success.
Investors may purchase shares in products they use on a daily basis. The majority of individuals use some kind of technology in their everyday habits. You may own a smartphone or a laptop, participate in social media, or shop for food or apparel online. With a technology stock, an investor may own a little piece of a company they are familiar with and enjoy.
Diversification is simple with technology. The IT sector is not a monolith. An investor may diversify their portfolio simply by investing in various sectors of the technology industry, such as social networking firms, smartphone glass producers, hardware manufacturers, software developers, and even green technology companies.
The wonderful thing about investing in the technology industry is that there is so much available, and investors must be able to discover something that fits their objectives, ambitions, and knowledge base.
The Disadvantages of Investing in Technology
Stocks have their own inherent risks and possible negatives. Tech stocks are no exception. As with any stock transaction, it's advisable to do extensive research prior to making a purchase. Consider these specific factors before investing in a technology stock.
The possibility of a technological backlash. According to some analysts, more regulation and governmental scrutiny might result in a backlash against technology stocks, jeopardizing their future prospects. They point to the European Union's General Data Protection Regulation's (GDPR) approval in 2018 and Facebook's congressional hearings as evidence that further regulation is likely in the future. However, similar to many other areas of the stock market, distinct technology equities respond differently to market volatility.
Purchasing what you know might be challenging. Warren Buffet has said that he would only invest in businesses that he understands. While you may have a firm handle on a few of the social media corporations, for example, certain upcoming technologies may be more difficult to comprehend. You may need to consider if you want to invest in a business that you do not completely understand.
Stocks may be overpriced. Certain technology businesses, such as Amazon and Google, have stocks that are well into the four figures, making them seem out of reach to a first-time tech stock investor.
The IT industry is enormous, and it is growing at a breakneck pace as machine learning, artificial intelligence, as well as other technologies push the envelope. There is almost certainly a business out there that might meet the objectives of each investor.
New entrepreneurs are building firms in garages as well as basements, pursuing the next big idea that has the potential to revolutionize the world (and perhaps mint a new college-dropout millionaire!).
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