Investing in Tech Stocks

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.

Software companies are increasingly moving to a software-as-a-service model, wherein customers buy a subscription to a program 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 the video streaming companies that provide easy access to high-quality content; and so are the 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.

• Amazon.com (NASDAQ:AMZN) is the leading online retailer and the leading provider of cloud computing infrastructure.
• Microsoft (NASDAQ:MSFT) is a dominant software company known for its Windows PC operating system and Office productivity software.
• Apple (NASDAQ:AAPL) makes the iPhone, the iPad, and Mac computers., Intense customer loyalty ensures plenty of repeat customers.
• 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.
• Cisco Systems (NASDAQ:CSCO) is the dominant provider of the enterprise networking hardware that forms the backbone of the internet.
• Netflix (NASDAQ:NFLX) is the top dog in the video streaming industry, spending billions of dollars each year on content to keep 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.
• Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) is the parent company of online search giant Google and the popular Android operating system for smartphones.

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

The impact of the COVID-19 pandemic

The pandemic has been a mixed bag for the tech industry. Amazon has thrived as consumers have shifted hard toward e-commerce, with higher sales easily offsetting additional pandemic-related costs. Microsoft has also done well, buoyed by demand for collaboration software, devices, gaming, and cloud computing services as people spend more time at home.

Apple held its own during the early days of this crisis, partly thanks to economic stimulus measures passed by Congress and partly thanks to the launch of the affordable iPhone SE. Apple’s pricey devices were in demand early in the pandemic despite a highly uncertain economic environment, although the delayed launch of the iPhone 12 family due to supply chain disruptions eventually hurt iPhone sales. The iPhone 12 features 5G technology, but a weak economy could hamper sales as the pandemic drags on.

High demand for devices has helped Intel as well, with sales of laptops surging as people work from home. Intel’s data center business is another beneficiary, with customers snapping up powerful server chips to support cloud services. Semiconductor stocks have done well during the pandemic as demand has soared for various types of chips.

Intel rival Advanced Micro Devices (NASDAQ:AMD) has also been thriving. AMD’s latest Ryzen 5000 PC chips outclass comparable chips from Intel across nearly every metric, which will almost certainly lead to more market share losses for Intel.

Cisco hasn’t been so lucky. While the company’s videoconferencing business is booming, the core networking hardware business has suffered as customers pull back on spending. While the pandemic is hurting Cisco in the short term, the shifts toward e-commerce and working from home could ultimately boost demand for networking equipment in the long run. The internet of things should also be a long-term growth driver for Cisco as an increasing number of objects and devices are connected to the internet.

Netflix has seen its user base grow rapidly during the pandemic as people stay home. The company had to temporarily pause production of all shows, but that didn’t stop people from signing up for the service. While the pandemic has helped Netflix, it also drove incredible growth for Disney’s (NYSE:DIS) Disney+ streaming service. Disney+ attracted more than 86 million subscribers in only its first year of operation, and the company could eventually overtake Netflix thanks to its vast catalog of content and its new streaming-centric strategy.

Both Facebook and Alphabet depend on advertising sales, so the steep decline in advertising from hard-hit industries like travel hurt both companies. Facebook held up better, managing to grow advertising sales during the worst of the pandemic. Alphabet suffered a small revenue decline, the first in its history.

Both Facebook and Alphabet are now facing antitrust lawsuits in the U.S. The Justice Department along with 11 state attorneys general sued Alphabet’s Google in October, accusing the company of anticompetitive behavior related to its search advertising business.

Facebook was sued in December by both the Federal Trade Commission and 46 state attorneys general. The suits allege that the social media giant used acquisitions to eliminate competitive threats. The FTC is looking to force Facebook to divest Instagram and WhatsApp.

Only time will tell how the long-term trajectories of these major tech companies have been altered by the pandemic, as well as by increasing antitrust scrutiny from the U.S. government.

How to analyze tech stocks

For mature tech companies that produce profits, the price-to-earnings ratio is a useful metric. Divide stock price by per-share earnings and you get a multiple that tells you how highly 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 can’t evaluate them. 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.