Monday, May 27, 2019

Thoughts on Technology stocks

Over third of our portfolio is invested into technology stocks. But what is considered a "Technology company" ?

It seems "Technology" in this context has come to mean computer, computer networking and electronics related technology and services:

  • Digital electronics (includes computers and components thereof)
  • Software
  • Services making use of computers and networking (e.g. on-demand video over Internet, e-commerce etc.)


Intel core i7-970 pin side
Image: Rainer Knäpper, Free Art License


"Tech" companies are often spending a lot on research and development (R&D) activity and many of them end up having sizable patent portfolio over time that protects their core innovations. 

I know R&D very well having spent more than 20 years in the front lines of technology development. It can be described as endless running competition. Even if you would have the advantage of being first in some space, you need to continue as others - perhaps companies 10 times your size - will be looking to enter the competition.

Netscape was first to release modern browser and it was at the time superior to anything before it. They were undisputed market leader in the mid 1990s with over 90% market share. Yet, by 2006 they had just 1% market share as Microsoft and many others invested heavily in their own browsers.

People typically see only the winners and forget the losers. For every "tech" that have made it big time there are tens of losers. And even those that make it "big" may not last for a very long time. This makes investing in "tech" very tricky. 

I have seen many first releases of a product and can say that in many that release will need considerable patching later on. Perhaps even second major release to really get it solid. The thing with R&D activity is that the more you have released the more you have to maintain. The maintenance part may - depending on the nature of the business - tie significant amount of R&D engineers. In the worst case, you need to also customize the releases for a given customer increasing the parallel software branches still.

Over time it is also easy to get locked in to a particular platform. Nokia's former mobile phone business is a famous example of this. They were so heavily locked to Symbian that they just could not pivot fast enough and were overrun by iOS from Apple and Android from Google. Apple didn't invent smart phone. They observed the market and available technology and eventually came up with far better design with iPhone that anyone before them - by a wide margin. They also came up with "Apps" and made the ecosystem fly.

Especially big tech companies have this kind of option that Microsoft used with browsers and Apple with smart phone. They can observe and learn from existing players while making their first release. If you are big (and skilled) enough, you can catch up pretty fast.

Therefore, small technology companies have to grow big fast or they risk being overrun. Many times the big will buy the promising small companies before they make it big. There are, of course, famous exceptions to this rule. The problem is that they are so visible and so good stories that people forget the "tech graveyard". The ones that didn't made it.

As an investor I tend to favor fairly valued established technology companies with long history, excellent brand and products, big enough footprint in their core markets, sizable patent portfolio and large R&D and sales departments. These are all things that are not easily replicated. For semiconductor stocks, you can add extremely expensive production lines requiring tens of years of know-how to build and operate.

It is hard to find "ten baggers" with this profile. However, it is possible to find companies that will see their market value grow many fold over time. That's good enough for me combined as it often comes with limited downside risk compared to whatever is currently "hot" in tech sector.

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