Technology companies and investing
Technology companies are becoming the top category of companies in the world by revenue and market capitalization. There are predictions that technology companies will become the best type of a company to invest in. Will these predictions come true?
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Looking at the fundamentals
Are tech companies fundamentally a good thing to invest in?
Fundamentally, shares (stocks) tend to be high risk choice for an investment. Stocks are reflections not only of the business and its employees. It is also a reflection of the changing political, demographic, and economic states.
Technology companies should be regarded as high risk investments. There are many reasons to take this outlook towards investing into technology companies. These are: the race for leading positions not being over, the disproportionate effect of trends on communication technology companies, and the fragile revenue streams of some the giants of the industry.
Looking at the technical indicators related to share and company performance can help in the evaluation of the fundamentals. For those unfamiliar with them, Stock trading. The technical side explains the main technical indicators.
The beta values of top 20 technology companies by market capitalization reveal an interesting cluster. The most common range for them is between 1 and 1.5, and the highest diversity for beta values is found in companies with the lowest market caps – up to $200 billion.
Top technology companies also trend towards beta values higher than 1. It’s interesting to note that the company with the lowest beta value – Tata Consultancy Services – has the second lowest market capitalization. The company with the highest market capitalization, Apple, in contrast, has the fourth highest beta value.
Moreover, only 25% of the top technology companies have a beta value lower than 1. Hence, not only are technology companies are a rather volatile choice for an investment, but also they have a rather high tendency to move along with the direction of the whole market.
The shares of technology companies, contrarily to the public opinion, are not overbought. The majority of the top 20 companies’ shares have a P/E ratio lower than 50. As beta increases, there is a barely-there trend of a P/E ratio increases. Hence, there are some companies which not only have volatile share prices, but also investors looking to pay higher sums for owning shares.
The shares of the leaders of top technology industry trend towards high P/E ratios. Yet, there’s a large contrast between software (marked in orange) and other companies (unmarked). 70% of technology companies with the highest P/E ratios are software companies.
That’s a worrying statistic. Software is “in”, but as any trend, it won’t last forever. The very large difference between overbought shares could lead to hard tech (physical goods) companies being the wildcards of the industry.
STOXX® Europe 600 Technology and Dow Jones Internet Composite show many interesting trends related to the industry. The two indices separately track top European and American technology companies.
From 2015, both European and American technology companies saw strong growth. American companies more strongly, but European tech industry followed the same trends. The difference between growth isn’t worrying, but can be perceived as a negative by investors.
The performance of the indices in the past 5 years looks promising.
The Aroon indicator (bottom of the chart) is not a fundamental indicator, yet very useful for the complete picture of the tech industry’s value for investment.
Aroon’s performance for the past five years shows that trend changes have been occurring less often. Hence, the rather high volatility of top tech stocks is not doubled down by whole industry volatility.
The common presence of the Aroon up line above the Aroon down line shows that the tech industry has been more bullish, rather than bearish. The Arroon up line being at 100 suggests that a new uptrend could have started. Yet, there’s still cause for waiting – the Aroon down line is still at a rather high number (over 40).
Altogether, technology businesses trend towards being a rather high risk investment. These companies have had good 5 years, and the investor enthusiasm, even if worse time will come, should be a positive influence.
Will technology expectations become reality?
There are several ways to model the future of the technology industry, and make assumptions on whether investor expectations will become the reality.
One is to look at general trends related to the technology industry. Through this, it is possible to predict whether technology companies will dominate the list of companies with top market capitalization, and the list of top companies by revenue.
Technology industry trends indicate a growing industry. The trends also can be used as a basis to make the prediction that tech companies will continue to be the top companies in the world. That’s because the industry does not look to be in the mature face, and a long way from being in a decline.
The main trends related to the technology industry have been those related to innovation. And not simple user experience improvements. The very different ways of organising not only the product, but also the business behind it, dominate innovation trends.
This shows that the industry is not only growing. The technology industry also has the funds to adopt innovation that won’t necessarily deliver good outcomes immediately.
Other trends in the technology industry have been a diversification of products and/or services offered by a single brand and increasing championing of governmental tenders. Additional revenue streams should help to keep technology businesses in top positions. Yet, by acquiring a new customer segment, the already existing ones could suffer.
Two revenue models of the industry
It’s also important to split businesses by revenue models. There’s two distinct groups: direct and indirect revenue. This distinction between revenue models is present in the segment of soft technology.
Many oversimplify the problem of direct and indirect (ads, charges for upgrades) revenue models in the technology industry.
It is true that a business earning indirect revenue is far more vulnerable to the volatile opinions of ad buyers. However, the discussion of the two models often misses the point that indirect platforms can, as direct revenue businesses, up-sell to their user base. The indirect revenue model, similarly to direct revenue companies, allows for businesses to create a product once, and to earn continuous revenue.
A distinction is present between soft and hard tech companies. It’s almost impossible to earn continuous revenue when a physical good is sold – the sale is the only revenue that will be received. While some hard technology companies have run ads in their devices, this trend is ending. Unless, by a miracle, users will be sold on advertising on their refrigerators.
This shows that soft technology company have one benefit over hard tech businesses, and both direct and indirect revenue companies enjoy it.
The indirect revenue model allows to sell to the user once – when they sign up. Then, in the best case scenario, ad revenue starts flowing without breaks. Of course, as long as the user continues to use the service.
However, there’s still more risk compared to direct revenue soft technology companies. Direct revenue companies have to sell to just one client – the user. For indirect revenue companies, both the user and the advertiser are clients. And the expectations of both have to be met. Double the work, but not always double the revenue.
Hard vs. soft tech
The distinction between hard (goods) and soft (software, technology as a service) technology companies is an important one. The two segments have to deal with different challenges, and responses to them aren’t always the same. Modelling the future of the industry, without separating the two segments, could yield inaccurate results.
From conventional perspective, technology companies making machines and goods, rather than services, should always be a more stable and less likely to experience volatility in terms of share price. With the abundance of services on the internet and physically, loyalty to them would seem almost absurd.
Let’s look at “hard” tech companies unconventionally. For one, customers can be said to be experiencing more loyalty towards services brands. Moreover, companies producing physical goods are often slow to appropriately respond to new trends, and may altogether fail to change their products or abandon the unsuccessful ones.
From these observations, the segmented future of the tech industry can be predicted. If the current trends will continue, it’s likely that hard tech producers will fail to appropriately respond to the new age of innovations in technology. It is also possible to assume that when the race for leading positions will end, soft tech users will generate additional benefits through their loyalty to specific brands.
Fintech
Financial technology (fintech) occupies a space in-between technology and finance industries. On one side, fintech companies deliver financial solutions. On the other, the solutions are built from technological products.
The effect of technology innovation or its costs is a rare talking point in fintech circles. However, even a slight change in the technologies that power fintech, will have a large effect. Thus, the duality of fintech makes predicting its future a more difficult task.
Finance companies have lost their winning positions since the 2008 crash. It’s hard to estimate whether this trend of a decline will eventually catch up with fintech. If the technology industry will see increasing supply and innovation, then fintech solutions could see a decline in costs. Thus, leading to a higher adoption of financial technology solutions by consumers.
So far, fintech growth has been increasing steadily. Moreover, financial technology companies are spreading to new locations far more aggressively than traditional finance companies. This is trend is important, since many traditional finance firms aren’t expanding, or are expanding to one or few most promising markets.
If the same growth trends will continue, then fintech businesses could see stronger positions in both business and consumer markets. Even without a decline in the costs of technology on which the industry is built on.
Technology production trends
Several trends in the production of technology goods and software have emerged since 2015. These have been innovation based on user requests, acquisitions instead of development of own technology, and user-oriented data solutions.
The effect of these trends on revenues of technology companies should be worthwhile.
Innovation based on user requests is the most beneficial trend to end users to emerge in the past 5 years. User submitted requests are being used more and more often for determining the direction of future developments.
This causes users to feel a deeper tie to the product. A deeper tie to a product should mean a higher conversion rate of customers to brand evangelists. Brand evangelism, in turn, creates a positive effect on company revenues.
Acquisitions of technology companies that create a product which is competing with the first company’s one, or which would improve the quality of service, have become more common.
Acquisitions have a possibility to take up a long time due to negotiations. Yet, they are the faster way to deliver innovation to users. Faster delivery of innovation means both creating a positive brand image (if customers expect the brand to be “fresh” or “innovative), and being ahead of the competition.
User-oriented data solutions in this article are defined as the information given to end users about their behaviour related to the service or good they are using.
Metadata has long been the hidden constant of the technology industry. Few software companies are delivering it, and not all apps.
There are companies whose product is solely metadata. However, for others, increasing delivery of metadata to users presents an opportunity. Data solutions not only increase the value of the product to the user, but also to offer a new capability and function of their product (assistance).
There are always two sides to a trend. From an unconventional perspective, heavily relying on the opinions of users for the direction the product takes (innovation), can backfire.
Serving one segment of users, while ignoring others, or taking a direct approach to user requests, often leads to the decreased value of a product. Ignoring internal innovation attempts in favour of user requests is not only damaging to company morale. When all innovation comes from users, many will feel that the company is only responsive, rather than truly “innovative”.
Production trends and investing
There’s an important distinction in investing that often gets forgotten. Some trends and practices contribute to higher revenues. At the same time, the trends don’t always contribute to higher profits. User-oriented and based solutions are more likely to deliver higher profits, along with higher revenue. However, the trend of acquisitions, instead of internal innovation, could become a risk to the bottom lines.
New trends open up new opportunities for businesses to fill. This would cause the competition in the technology industry to increase.
The trends of innovation based on customer requests and delivery of data solutions to customers have the potential to increase competition. They both heavily depend on deeply analytical and creative work to deliver them. Companies cutting corners on these types of work, risk delivering products that don’t correspond well to the true needs of the customers.
The acquisitions over the development of own technology, as a trend, should be beneficial to investors into older technology companies, rather than newcomers.
For industry newcomers, the option to get acquired, rather than to grow independently, will cause many to choose this route. Foregoing an independent vision and control of a company will lead many leaders of younger companies to abandon their own projects. For older industry players, this will lead to easier competition, when only the industry giants are a threat.
Why technology?
Successful investing decisions involve a separation of personal feelings from the decision-making process.
There always will be “lightbulb” moments when an interaction with a certain product inspires a successful investing decision. For all other cases, the technology industry is a multifaceted one, with several different segments. When the complexity is taken into account, separating personal (diss)satisfaction with the products becomes even more important. Even when trends beneficial to the industry are front and centre.
Disclaimer: this article is not intended to be taken as investing advice. Only the investors are responsible for their losses or gains.
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