John Reese is CEO of Validea.com and Validea Capital, and portfolio manager for the National Bank Consensus funds. Globe Investor has a distribution agreement with Validea.ca, a premium Canadian stock screen service. Try it.
Social media and "new Internet" stocks such as Twitter and Yelp – as well as private companies such as Uber and Lyft – get a lot of attention in the financial media these days. It's to be expected – we humans are obsessed with new things, and we get infatuated with "potential." Why else would more than seven million people have spent an evening watching Round 1 of the recent NFL draft?
But when it comes to investing, I'll take "proven" over "potential." And while the tech sector talk often focuses on potential, it holds plenty of proven plays, too. IBM, Microsoft, Apple and others have gone from being fast-growing small companies to big, steady stalwarts. It's an inevitable transition. You can't grow earnings at 50 per cent a year forever; companies can only get so large. In addition, spotting the next Apple, which has increased in value by more than 29,000 per cent since its 1980 IPO, is equivalent to finding a needle in 10 hay stacks. Ask around – do you know anyone who invested in Apple in the early days and stuck with the company?
I think investors face two major challenges when investing in less-established, although exciting, technology firms. Both of these are challenges that Warren Buffett, whom I try to emulate, has pointed out with high-flying tech names and why he avoids them.
The first has to do with earnings. Young companies in emerging industries often have very little and highly unpredictable earnings. When earnings are unpredictable and the business does not have a competitive moat around them, stocks of these companies can fall dramatically as competition emerges and the potential for profitability erodes. Canada's once darling tech company, BlackBerry (the former Research In Motion), is an example of how quickly a business model, and profits, can change in the technology and hardware landscape.
The second has to do with valuations. Yes, some of these companies may be growing at 30 per cent to 40 per cent – or even more – but when they trade at astronomical price-earnings or price-to-sales ratios, any disappointment or even hiccup in growth is likely to put the stocks out in the woodshed with investors. Disciplined fundamental investors understand that companies with valuations two, three or even four times that of the market are mostly unsustainable over long periods of time.
Such comments on some of the hot tech firms of the day might sound subdued coming from an MIT grad and technology entrepreneur turned money manager, but I put the facts and my experience ahead of my emotions and biases when it comes to investing my firm's capital and the funds I run. You should do the same.
A few years ago in this column, I wrote about the transition going on in the tech sector in which one-time high-growth, sexy upstarts were maturing into large, steady, overlooked industry stalwarts. Just as back then, I still believe investors should focus on fundamentals and valuation – even in the potential-crazed tech arena. I'll be the first to tell you that many of the big tech stalwarts aren't producing wild growth any more, but they're flying under the radar of many investors – and that's good. Fears of competition and new advances have made investors leery of them, even though they continue to produce strong results and crunch out earnings. That combination of fearful investors and strong companies is a value investor's dream, and it's meant that many large, "old" tech firms are catching the eyes of my guru-inspired investing strategies, each of which is based on the approach of a different investing great.
Many of the stocks in the accompanying table aren't without their own set of challenges, to some extent, but even in the growth-obsessed tech sector, investing is about value.
The 10 stocks shown are taken from Validea's Advanced Guru Stock Screener, sorting the technology sector by market cap and looking for the companies with the highest scores from one or many of my guru-based computerized models.
Disclosure: I'm long IBM, AAPL, TSM, HPQ.