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How To Invest In Tech Stocks

15 January 2009 11 Comments

Tech stocks are probably the hardest sector for investors to make money. There are significant obstacles that come with investing in tech such as the hype surrounding the sector and individual stocks, large price to earnings multiples and lots of volatility.

Furthermore, one of the biggest aspects of most tech stocks is the lack of dividend payouts (the tech stocks that do have dividends are typically very low yields). The lack of dividend is typically justified by calling these stocks ‘growth’ stocks; however, this poses a serious challenge for investors. With no dividend payments, the only way to make money by investing in tech is buying a stock and selling it for a higher price. This might sound obvious, but this is the most important thing you can take from this article.

Buying a stock and selling it for a gain is much harder than most think, especially your average-at-home investor. Assuming you are not a day trader, generally speaking, you will have to buy a tech stock in a bear market and sell it in a bull market in order to make money on the position.

Most Buy Tech During Bull Markets

Tech stocks typically get a great deal of attention and hype, especially during bull markets. Since average investors must do their own research using the internet or television, there is much more press and coverage over certain tech stocks than other “unsexy” companies (think Apple vs. General Mills). Because of the hype around a upwardly charging tech stock, many will buy into tech during a bull market; usually, this will happen after the large move upward.

Why do people not buy tech during bear markets? Well, for one, tech stocks get punished during bear markets. Since tech stocks typically have higher multiples, these stocks will always get pummeled during a bear market. Most average investors struggle pulling the trigger on a position that is down 50%, 60% or more.

To sum up, most people buy tech stocks during bull markets, not bear markets; which, in many cases, will end up losing money.

The Challenge Of Selling A Position

Most investors struggle selling a position in any case. Emotions, mainly greed, get in the way of making an objective sell. If you’re down, you want to get back to even then sell. If you’re up, you want the ride to go just a little higher, then you will cash out.

With tech, it’s even harder. If you’re lucky and you buy during a bull market, yet the bull continues so you have some paper gains, you end up thinking that this investing game is so easy. You get overconfident and you don’t take your profits. Other times, the volatility is so huge that you end up quickly selling for a loss instead of ignoring the day to day fluctuations.

The Best Way To Buy And Sell Tech

Because there is so many emotional and timing issues involved with buying a tech stock and selling it higher, it is better to have a straight forward strategy for average investors when it comes to investing in tech. As I mentioned earlier, this strategy is to buy tech during a bear market and sell it during a bull market. If you think you might struggle sticking to this strategy, forget tech and stick to dividend plays, because remember, the only way to make money in non-dividend stocks is to sell the stock at a higher price than you bought it.

Now, this strategy does not apply to every stock. Just because it is a bear market and it’s a tech stock does not mean the stock will be higher once the market turns. You must find fundamentally sound companies with proven earnings and strong competitive advantages heading into the future. Note: this eliminates speculative companies that claim to have the next big thing without earning a dime yet.

Tech Example: Apple Inc. (AAPL)

Apple is down huge from its peak. Currently around $90 a share, Apple once traded over $200. What is its true value? Well, probably somewhere in the middle but I wish to illustrate why it was a bad move to buy Apple during the bull market. You would have bought in the upper 100’s and held the stock as it dropped down. Now, let me make this clear, I’m not referring to trading. Traders may have bought at $150 then sold at $170 for a profit. I am spefically referring to investing over the longer term, at least a few years.

Also, it is worthwhile to illustrate how an incredibly healthy company like Apple still gets pummeled in a bear market. No stocks are safe during a ruthless bear market.

The important question is… Is Apple a good buy today for an investor willing to hold the stock for a year or 2 or 3 (or longer)? Here are the fundamental reasons that support owning Apple:

  1. Strong Balance Sheet – $25 billion in cash and growing with zero debt.
  2. Continuous Innovation – Is there really another company where so many people get excited about what they might come out with next? Whether it is smart phones, laptops, operating systems, consumer software, media… Apple continues to push the envelope with new, innovative products.
  3. Market Share Growth – Apple continues to chip away at market share in a number of areas. Macs continue to outpace PCs in growth. The iPhone is an amazing success in the cell phone arena, especially the smart phone arena. The larger the market share of Apple when the broad economy turns, the more future earnings potential.
  4. The Platform – This might be Apple’s biggest competitive advantage. Their iTunes platform exists in just about every home. All Apple products are designed to take advantage of this platform whether it be your TV, your phone or your computer. The Apple eco-system that has been created is simply genius. This will continue to give Apple the advantage whenever someone is researching what product to buy.

Given these factors, it looks like Apple may be a bear market buy candidate. We know they have plenty of cash to operate during lean times. We know they will continue to come out with outstanding products. Growing market share in lean times might prove to be a huge plus when the overall market expands. Let’s look at a the risks.

  1. The U.S. Consumer – I am incredibly bearish on the U.S. consumer. This is my #1 concern with Apple. Thankfully, Apple has geared much of its growth focus on the international market. I’m really curious about China.
  2. Expensive Products – Apple’s products are expensive. In some cases, 3 and 4 times other products. However, I believe that the quality warrants the premium pricing. Apple is maintaining their premium image and their products continue to improve. Sure, you can get a $600 laptop, but people would still rather have the MacBook. Is there still a premium market during a recession? I believe so.

Apple Conclusion

The bottom line is that Apple is a very healthy company. Arguably, they have a stronger product line than ever before in their history. They are advancing on multiple fronts: phone, computer, etc. What other companies are doing this?

The risks that exist are there for most companies during a recession, namely people stop spending as much. This will definitely hurt Apple’s stock in the short run. What about the long run? I believe Apple will be positioned better than any of their competitors to come out shining on the other end of this global economic downturn.

My worry is that the current economic downturn will last longer than most think.  Therefore, the next bull market to push Apple’s share price sky high might not come around for a while.  I think Apple shares will likely trade flat for a while.  I think the stock is a good buy but you might have to hold it for a while to get any significant upside.  If the stock somehow gets pushed lower (maybe 70’s or 60’s), think about buying some shares for your long term positions.

What You Should Take From This Article

Perhaps, you should buy Apple. More importantly, I hope you see how to make money on a tech stock. I hope the Apple example gives you a solid example of what it might look like to buy a healthy tech stock during a bear market.

Additionally, there are two laws of tech that you must never forget:

  1. With no dividends, you must sell the stock for a gain to make any money.
  2. Most investors should either avoid tech stocks and stick to dividend stocks or commit to buying tech only during a down market and then selling it during a bull market.

I hope this guide helps!

11 Comments »

  • Matt Peer said:

    Healthy companies need healthy CEOs too…looks like that obituary might come true this year.

    Cook’s a good guy, and capable, but admit it, Jobs is AAPL. No CEO out there has his vision or demand for excellence.

    Also, I am suspect of AAPL because of the manner management communicates with shareholders. Just one week ago they made mention of Jobs having a hormonal problem, no big deal. Now? Stepping down for “six months”. Again, paint me a skeptic.

    Kevin, I really think this post warrants a legitimate discussion of this aspect.

  • Kevin said:

    Apple was just an example of how to look at tech stocks in a bear market. This post is not intended to be a full Apple discussion.

    The Jobs thing is definitely an important aspect of looking into buying Apple. Personally, I don’t think it’s as big a deal as most shareholders. Jobs is amazing but I think his vision is very much ingrained into Apple at this point and I think their earnings are safe for years. Ten years from now? Maybe not.

    I’m hoping Apple hits low 70’s or 60’s, I will be a buyer at those levels.

  • Matt Peer said:

    You’re missing my point. It has to do with TRUST in management. If you can’t trust them over handling the communication of the public face of the company, how do you trust them?

    Take MSFT-YHOO. What side were investors to believe in that deal, Ballmer or Yang? did MSFT offer $33/share? Did Yang oversee a spectacular decline in the stock price of the comapny he founded?

    Management trust is an important aspect, especially in tech stocks.

  • Kevin said:

    Trust in management is important. You’re right. And Apple has indeed taken a hit in this area as you have noted.

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