This month at The Motley Fool, we're taking an all-hands-on-deck approach to getting back to basics, culminating on Sept. 25 with Worldwide Invest Better Day. With this in mind, my Foolish colleagues and I are opening the floodgates with vital information to help you invest better. In a previous article, we reviewed stock diversification, a key fundamental of investing. We're taking a look at stock sectors one by one, and we're focusing today on tech stocks.
The ins and outs of the sector
Consumers, businesses, and governments all purchase tech goods and services, typically more often during periods of economic expansion. Consumers buy PCs, smartphones, tablets, and TVs. Businesses and governments receive information from software and database systems.
Tech stocks carry a higher risk profile relative to other sectors driven by continuous innovation. Rapid obsolescence is a consequence. Today's hot tech stock may be a dinosaur tomorrow. As a result, successful tech companies constantly innovate.
How the sector performs
Tech stocks typically outperform the overall stock market when the economy is purring along. During these times, businesses, governments, and consumers are gobbling up tech products and services. From March 2009 to present, the tech sector has returned 151%, versus 131% for the S&P 500. During a weak economy, the sector usually underperforms. After the tech bubble burst in 2000, the sector lost roughly 63% from 2000 to 2003, a time when the S&P 500 lost 19%. And over long spans of time, the sector usually outperforms. During the past decade, the tech sector returned nearly 157%, versus 98% for the S&P 500.
Major players, big trends
Semiconductor chips are the lifeblood of our computers and mobile devices. Chip-fabrication equipment maker Applied Materials (Nasdaq: AMAT ) has seen orders, revenues, and earnings decline recently, and the company lowered its outlook for the year. But as the economy expands, manufacturing picks up, and demand for tablets and smartphones grows, chip-related companies such as Applied will benefit.
In the industry's shift from servers to service, cloud computing has emerged. Cloud computing allows us to access resources through networks instead of running slow software or storing bulky data on our computers. Both Rackspace Hosting (NYSE: RAX ) and Amazon.com (Nasdaq: AMZN ) are venturing into this pay-for-what-you-use model but are approaching it in two different ways. Instead, Apple (Nasdaq: AAPL ) , trading at an all-time high, makes its money on the hardware and software. Apple's record sales of its prolific iDevices are driving mobile data traffic to new highs. Global mobile data traffic more than doubled last year and is expected to double again in 2012. One similarity between these three companies? Their stock-price performance. All boast 52-week highs, and Rackspace, Amazon, and Apple have enjoyed year-to-date returns of 52%, 46%, and 68%, respectively.
Habitually hop on Facebook (Nasdaq: FB ) to check out your brother-in-law's most recent shenanigans? You're not the only one. Social networks not only disrupt our daily lives but also hold the potential to disrupt many industries. Companies mine data from social networks to understand how we react to their new product launches and marketing campaigns.
Tech IPOs tend to attract a lot of investor interest, especially when the company is well known. But that excitement isn't always matched by investment returns. Buyer beware: The average stock-price change for LinkedIn, Groupon, and Facebook three months after their respective IPOs was negative-24%.
An easy way to own the sector
Using the MSCI World Sector Weightings as a benchmark, roughly 15% of your overall stock portfolio should be allocated to the tech sector. But do your homework before investing in tech stocks. As with all stocks, don't let your love of a company's product cloud your judgment as to the company's viability as a profitable investment. The two don't always go hand in hand.
But if you're overwhelmed and clueless when it comes to tech stocks, don't fret. Consider exchange-traded funds. Some ETFs mimic the performance of an index, such as the S&P 500; others provide specific exposure to certain sectors. Sector-specific ETFs such as the Technology Select Sector SPDR ETF are helpful when you look at tech stocks like a deer looks at headlights.
If you bet wrong in the stock market, it could cost you dearly. Instead, develop a diversified strategy for adding all sectors to your portfolio. That way, regardless of what happens in the market, you'll sleep well at night knowing a portion of your portfolio will prevail. And if you're interested in learning more about tech dynamo Apple, you're in luck, because I've put together a comprehensive iPhone 5 report on all the likely suppliers, and how to profit on Apple's new flagship device. It's included as a bonus for subscribers of our Apple research service, which also comes with free updates for a year. Sign up today.
Join us for more investing basics on our microsite for Worldwide Invest Better Day. We've posted many great articles there aimed at helping you do just that.