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By any measure, Etsy (NASDAQ: ETSY), the online marketplace of handmade items, is a highly innovative business that has used technology to transform retail and empower thousands of small merchants. And by any measure, Etsy’s IPO earlier this year has been a flop. Since debuting amid high hopes at $31 a share in April, it has tumbled to below $9 today.
Then there is Amazon.com (NASDAQ: AMZN), another retail-focused tech business that was the first major player on the consumer Internet a generation ago. Although the company is well into middle age, it shows no sign of slowing down: Amazon shares have more than doubled in the past year.
Confused? Well maybe you shouldn’t be. While it’s true that no one can predict with certainty how tech stocks will move, we do have some tools at our disposal that will help us make more informed selections.
Here are some do’s and don’ts of investing in high-tech stocks.
Don’t focus only on what you understand. It was Warren Buffett who famously advised individual investors to avoid investments in businesses that they didn’t understand in favor of those that they did, but there are a few problems with this line of thinking and the way investors too often interpret it.
For one, Buffett for all his wisdom came of investing age in a much lower-tech time. Today some of the best investments are in businesses like cloud computing and big data that many of us will never understand in depth. But that doesn’t mean we should focus instead on a business like Etsy just because we shop there.
Do read up on enterprise software. While you may never be able to speak like a software developer you should understand that much of the money being invested in technology is being invested by businesses seeking to improve processes and efficiencies.
Even a business like Etsy no doubt has a robust enterprise software to ensure that the consumer-facing end of the business works. These are typically very complex businesses, but if you seek to understand the trends driving them, you’ll be better positioned to pick winning stocks.
Don’t get stuck in 1999. And, if you weren’t investing in 1999, the advice is still the same: don’t cling to any moment in time. One of the reasons that it may be so hard to fathom Amazon’s meteoric rise is that we still think of it as a upstart online book retailer, or maybe a diversified retailer, but we are not fully recognizing how well it has come to dominate the cloud computing sector with Amazon Web Services.
Do understand that the best tech businesses are continuously innovating. This is true of any good company, new economy or old. But the difference in technology is that the sky really is the limit to how far a company might go from its original business. When car companies innovate they are, for the most part, focused on making better cars. Amazon, on the other hand, went from paper books to e-books to web hosting.
Even companies that do not transform as dramatically as Amazon frequently have fortunes that rise and fall based on how they are innovating in their industry. This is why a company like software security maker Imperva (NYSE: IMPV) has had such dramatic stock swings in recent years and why it has been able to innovate its way out of a steep stock slump just a year ago.
Don’t focus so much on killer apps. There’s a kind of legend around the tech sector that suggests that anyone who develops that elusive killer app will transform the world and make millions. The reality is that lots of businesses start out with the potential to have a killer app, but the devil is in the execution. Alphabet (NASDAQ: GOOGL), the company that was until recently known as Google, is perhaps the best example of the triumph of execution over ideas. Google was not the first (or the second, or the third Internet search engine). But it came to dominate the space through is superior execution.
Do focus on management. You might not be able to manage your way out of a poor technology, but once a company has a winning technology, strong management is absolutely essential in everything else I’ve discussed in this piece, from staying ahead of the competition to innovating into new areas.
Not convinced? Look no further than Twitter (NYSE: TWTR), which has a technology that transformed the way the world communicates but which has lost the faith of investors after a period of confusion over its future direction and its leadership. Twitter shares are down more than 25% year-to-date.
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