Investing in tech stocks can be a risky business. Most of us remember the carnage that ensued when the dot-com bubble burst in 2001, an event that saw huge swathes of investors lose up to 75% of the value of their stocks. The catastrophe has since caused a high degree of caution regarding tech stock in the investment world, with many investors deciding to stay away from the sector for good. However, while the risk remains high, this must be considered a mistake since tech stocks have actually increased eightfold since 2001.
It goes without saying that if you had invested early in companies like Amazon or Facebook, you would have stood to make an incredible return on your investment. Nowadays, it is easy to think that you have missed the boat on tech investment, but the reality suggests something different. If you know what you are doing, the potential for profit in the tech sector is perhaps greater than any other. Here are a few things that you should look out for when looking for tech investment opportunities.
When identifying the tech stocks to invest in, there are a few key metrics that you should use. In addition to the fundamental tools that are used to analyze other stocks (competitive advantage, a healthy balance sheet and a fair valuation), you should also consider the following:
- Operational Leverage
Tech companies like software providers typically operate with a high gross profit due to low production costs. As a result, the largest proportion of costs usually falls under the category of ‘operational expenses.’ Investors should look to identify companies which are growing at a faster rate than their operational costs. The difference between these two rates is known as ‘operational leverage.’ If operational leverage is high, it usually indicates that a business is scalable and will be profitable in time.
- Revenue Growth Rate
One of the first things that investors look at when compiling lists of the top tech stocks to watch is revenue growth. Since tech stocks can fluctuate greatly, Wall Street tends to concentrate mainly on quarterly growth rates. A growth rate which is accelerating is usually an indication of strong momentum which could mean further growth in the immediate future.
- Range of Customer Base
Another key indicator used to identify strong growth potential is the breadth of customer base. Generally speaking, companies which rely on a small number of larger clients pose a greater risk than those which have a larger client base. This is because they are better insulated against the impact of the loss of a fundamental client which could be catastrophic for business.
The tech industry is one of the most dynamic in the world. Investing in tech stocks presents a massive opportunity for profit if you take care to analyze companies using some of the metrics listed above. Just make sure you do your own research before putting in your own money.