Tech stocks are dead. Long live technology investing.
The three great rules for finding a highly profitable technology stock still work as well as they did back in the days when, , and were the kind of stocks that set an investor's blood racing and produced lip-smacking profits for portfolios. (Microsoft is the publisher of MSN Money.)
I just don't think they work very well for traditional technology stocks anymore.
That's because, first, the technology sector has changed so radically since the good ol' days before the bear market that began in March 2000. And second, because changes in the energy sector -- yes, the energy sector -- have created stocks in that part of the market that show all the traits of technology stocks in the 1990s.
Sales, apps and marginsWhat are the three great rules of technology investing?
1. Look for the hockey stick. This has nothing to do with sports. Instead, the "hockey stick" describes a highly desirable pattern in a company's sales growth. Initially, sales start off at a low level and grow slowly over time, sketching in the blade of the hockey stick. Then, if all goes well, at some point sales start to increase more rapidly, creating the upward curve that is the stick's neck. And then, if this technology company is really onto something, sales take off and growth becomes almost vertical. That's the handle of the stick.
Do I need to say that you'd like to own a stock when the company's sales -- and earnings -- growth goes vertical?
2. Look for the killer app. The killer application -- the software program, piece of hardware, product improvement or whatever -- that everyone has to have is what powers hockey-stick growth. It took everyone a while to figure out what an Internet browser was and what it was good for, but once that period of slowly growing use was past, everybody had to have one because being browserless was just inconceivable. Same with digital cameras and wireless phones and, before that, with routers and personal computers themselves.
3. Look for a company with sustainable high margins. In the technology markets of the 1990s, a company could ride a sustainable proprietary edge -- and a willingness to ride that temporary advantage over the competition as if the devil was at its heels -- to years and years of outsized profit margins. As the company's sales climbed up that hockey stick, fixed costs would be spread over a larger and larger volume of sales, and profit margins would grow. As advantages of scale kicked in, successful technology companies would wipe out competitors that were unable to spread costs over a big enough sales volume, and that would allow the victor to increase profit margins again.
But these rules just don't fit the traditional technology titans very well right now. How they'll fit the sector in five or 10 years is anyone's guess.
New times, new rulesSo here are three new rules that are a better fit for the sector as it now exists.
1. Instead of hockey-stick growth, think mature blue-chip growth. Cisco Systems is a great company, but it now has more in common with a company likethan with the technology competitors of the 1980s and 1990s or today's technology-driven competitors, such as .
Cisco is now all about line extensions, about building on its strength in hardware to sell more software in much the same way that PepsiCo uses clout in cola and potato chips to grab shelf space for bottled water and "healthy" Doritos. It's all about motivating an already-hard-running sales force into running harder and harder each day. Investors who are disappointed that Cisco Systems is growing revenue by only 15% a year need to have their heads examined.
PepsiCo andwould kill for that kind of predictable growth. But if you're still comparing today's Cisco Systems to the technology model of the 1990s, I can understand the source of the reaction.
2. Instead of killer apps, think killer fashion sense. Why hastaken over from at the top of the wireless-phone market? Because Nokia does a much better job, year in and year out, at matching its phones to the fast-changing trends in the consumer market. (Well, Nokia's ability to actually manufacture phones efficiently so that it can supply a fashion-driven market at a healthy profit does have something to do with it.)
Even when Motorola delivered a hit such as the Razr, the company managed to quickly turn a hot phone cold because it didn't understand it was managing a fashion phenomenon. That's a fundamental mistake in this new market for technology goods that, a technology company that has become adept at selling the sizzle, would never commit.
3. Instead of growing profit margins, think shrinking margins. There's so much capital in the world now that a high profit margin becomes a red flag that draws a horde of well-funded competitors from around the world -- and at least a few of those are willing to run at a loss for years because the government that has arranged the financing has goals besides profitability. So many technology products are now produced by contract manufacturers that new competitors don't face a steep learning curve before they can efficiently manufacture a new product.