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Investing in Technology Companies

Technology is a popular sector within equity investing and a popular investment choice of equity growth style managers. The reason that this sector is important for growth managers, is that it is filled with companies who can achieve growth in excess of the overall market. Some companies in this sector will experience explosive growth in both revenue and EPS. While this sector has the potential for upside, there are also traps and pitfalls that the typical investor must watch out for an avoid.

Characteristics of Technology Companies

  1. Growth in Revenue: Revenue can grow in excess of the overall market.

  2. Growth in Earnings per Share (EPS): For some smaller tech firms, earnings aren't so important while they are in a growth phase. For these small companies, what's important may be different per investor, but in general investors can look at other metrics to value small and quickly growing companies.

  3. Like watching the Kentucky Derby: The first horse out of the gate doesn't always win the race. A tech company can burst out of the gate, only to find that their products aren't going to be as popular as once thought. And some very popular internet/tech/software solutions that are widely popular, just can't generate the amount of revenue and earnings that investors are looking for...Twitter for example.

  4. P/E multiples can be Useful and USELESS: P/E multiples, or the price-to-earnings for a technology company can be useful for the more stable firms that have a less parabolic growth trajectory. When you get into the smaller or newer names, the P/E can be less valuable as it becomes harder to estimate on a go forward basis and harder to read in a meaningful way. Amazon for example, has very high P/E and has had such for a long time. The reason for this is that the company is investing heavily into growing their business and investing into that growth. The investment community has overlooked the higher than normal P/E in hopes that the company will grow into this high valuation over time, Amazon has not let their investors down in this regard.

  5. Alternative metrics for Valuing small Tech companies:
  6. Ultimately, and as companies mature, they all at some point become valued like their peers. So even those companies who may be small now with high multiples, they too must eventually generate enough revenue to justify their valuations. This is important to keep in mind as the company grows and matures.






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