Investing in Tech Stocks

Updated: April 27, 2020, 3:28 p.m.

The technology sector is vast, comprising gadget makers, software developers, wireless providers, streaming services, semiconductor companies, and cloud computing providers, to name a few. Any company that sells a product or service heavily infused with technology likely belongs to the tech sector.

Hardware Companies

Design and build devices such as:

  • Personal computers
  • Smartphones
  • Fitness trackers
  • Smart speakers
  • Enterprise equipment like servers and networking gear
Software Companies

Design the software, including the examples below, that runs on hardware.

  • Operating systems
  • Databases
  • Cybersecurity software
  • Productivity software

Software companies are increasingly moving to a software-as-a-service model, wherein software is bought via a subscription instead of a one-time license. This generates recurring revenue for the software company.

Powering all that hardware are semiconductor chips. Semiconductor companies design and/or manufacture central processing units, graphics processing units, memory chips, and a wide variety of other chips that find their way into today’s devices.

Telecom companies that provide wireless services are part of the tech sector. So are video streaming companies that provide easy access to high-quality content. So are cloud computing providers that power those streaming services.

The best tech stocks

Many of the most valuable companies in the world are technology companies. These are some of the most dominant and impressive tech stocks.

  • (NASDAQ: AMZN) is the leading online retailer and the leading provider of cloud computing infrastructure. The company’s Prime membership program has hooked consumers on fast shipping, and its cloud services have become indispensable for countless enterprises.
  • Microsoft (NASDAQ: MSFT) is a dominant software company known for its Windows PC operating system and Office productivity software. Microsoft is also the No. 2 provider of cloud computing infrastructure, and it’s gaining ground on market leader Amazon Web Services.
  • Apple (NASDAQ: AAPL) makes the iPhone, the iPad, and Mac computers. While Android smartphones outsell iPhones by a wide margin in terms of units, Apple’s intense customer loyalty ensures plenty of repeat customers, and its premium pricing ensures lofty profit margins.
  • Intel (NASDAQ: INTC) is one of the largest semiconductor companies in the world. Intel designs and manufactures CPUs for PCs and servers, as well as specialty chips for uses like artificial intelligence. Intel enjoys a dominant market share, although smaller rival Advanced Micro Devices (NASDAQ: AMD) has been making a comeback.
  • Cisco Systems (NASDAQ: CSCO) is the dominant provider of the enterprise networking hardware that forms the backbone of the Internet. Despite a proliferation of low-cost competition, Cisco has held its own.
  • Netflix (NASDAQ: NFLX) is the top dog in the video streaming industry. Netflix spends billions of dollars each year creating vast troves of content, keeping its ever-growing subscriber base hooked.
  • Facebook (NASDAQ: FB) is the largest social media company. With over 2 billion daily active users across Facebook, Instagram, Messenger, and WhatsApp, the company has rapidly grown its online advertising sales while producing stunning profits.
  • Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) is the parent company of Google. Alphabet dominates online search, powers most of the world’s smartphones with its Android operating system, and has invested in various “moonshots” that could pay off big down the road.

Facebook, Amazon, Apple, Netflix, and Alphabet (Google) are sometimes grouped together and referred to as the FAANG stocks. These companies dominate their industries, and their stocks have produced impressive returns over the past few years.

How to analyze tech stocks

For mature tech companies that produce profits, the price-to-earnings ratio is a useful metric. Divide the stock price by per-share earnings and you get a multiple that tells you how richly the market values the company’s current earnings. The higher the multiple, the more value the market is placing on future earnings growth.

Many tech companies aren’t profitable; the price-to-earnings ratio is useless in those cases. Revenue growth matters more for these younger companies – if you’re investing in something unproven, you want to make sure it has solid growth prospects.

For unprofitable tech companies, it’s also important that the bottom line be moving from losses toward profits. As a company grows, it should become more efficient, especially when it comes to the sales and marketing spending necessary to close deals. If it’s not, or if spending is growing as a percentage of revenue, that could indicate that something is wrong.

Ultimately, a good tech stock is one that trades at a reasonable valuation given its growth prospects. Accurately figuring out those growth prospects is the hard part. If you expect earnings to skyrocket in the coming years, paying a premium for the stock can make sense. But if you’re wrong about those growth prospects, your investment may not work out.

Investing in tech stocks can be risky, but you can reduce your risk by investing only when you feel confident that their growth prospects justify their valuations.

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