Reasons to be cautious when investing in technology shares
The is real excitement about technology at the present. It is believed that it is going to change our society and how we live. This is creating a great many opportunities for technology companies. In recent years, some tech companies have dramatically increased in value, think of companies such as Salesforce. The so-called FAANG stocks are now driving the stock market in America. This has resulted in many investors pouring money, at an unprecedented rate, into tech stocks. There is no doubt that tech stocks have been a great investment for the past ten years’, but does that mean that this will continue. There are concerns that valuations in technology stocks are becoming stretched. Here are some things that you need to take on board when you are thinking of investing in technology stocks.
It is important to remember that we all love a great story. At the moment the narrative that is dominating the market. We all want to believe a good story. However, this may not always be the case. The current narrative about tech stocks is one that may mislead an investor when it comes to their allocation of capital.
Another good reason to be cautious about putting your money to work in the technology space is that everyone is doing it. This form of investment is now a ‘crowded trade’ and everyone is putting their money to work in shares of companies that sell or make computer software or hardware. This means that valuations are becoming frothy, based on some indicators such as the PE Schiller ratio.
There are concerns that the tech market is at peak. However, there are those who argue that it is actually going to take-off. An investor needs to be very cautious. One big concern is that now everyone is buying shares in companies that are involved in areas such as the cloud, cyber security etc. So many people have bought into it that there are some who believe that the number of buyers for these stocks is becoming limited. This could result in these shares falling in value.
Moreover, not every technology stock is a winner. If you believe the publicity every tech company is going to change the world and make lots of money. However, this is typically not the case. While many companies initially prosper they soon encounter problems. Companies that have successful IPOs have quickly run out of steam and many investors have lost money. This is the nature of technology companies. They are able to attract capital and generate high revenues very quickly. But they are often unable to translate this into regular and substantial profits, over a period of years. This means that many tech investments do not offer great returns over the long-term and indeed could result in the loss of the initial investment.
Many technology companies have one great idea. These ideas can be revolutionary and can allow them to generate a lot of profits. However, their one great idea or product is soon challenged in the market. This means that they face increased competition and their revenues fall. Moreover, many tech firms’ offerings are soon superseded by other start-ups. As a result, these companies have to continue to be innovative and to develop new products. If they do not they can soon run into problems and the company can experience real financial difficulties.
It is also important if you are a value investor to accept that many companies that sell hardware and software often are more interested in revenue and market share than profit. A good example of this is Amazon which until recently was not really concerned with making profits. Now if you want a regular dividend then the majority of technology companies may not be a good idea.
Another major issue for those who are invested in the tech space is the growing risk of regulation. Many companies may be badly impacted by the increased regulation of their business practices. There are now many who believe that increased regulation could impact negatively on the business models of companies. Many dependent on the ability of companies to use their customer or users’ data. This could change in the coming years. Moreover, there are some who argue that the financial reporting of tech companies is not properly regulated. This means that they appear to be more successful than they actually are. Indeed, many believe that there are echoes of the dot-com bubble at the moment.