I’m an optimist by nature.
I believe we are on the verge of an age of abundance. And this new age will be driven by the companies and technologies that focus on the top trends I cover in my newsletter, The Bleeding Edge.
I’m referring to technologies like 5G wireless networks, precision medicine, artificial intelligence, cloud computing, quantum computing, and the next generation of clean energy production – nuclear fusion.
But we have to be realistic.
Not all technology companies are great investments. In fact, even great technology companies can be bad investments. And I predict we’re on the verge of a “splintering” in the market.
What does that mean?
Companies whose products and services are well-positioned for this new economic environment are booming…
And those that aren’t are suffering. The next several years will be brutal for companies that don’t adapt quickly to this new environment.
More importantly, this splintering will send a small segment of the tech world much higher.
The pandemic pulled forward some tech trends by 5–10 years. For example, we’ve been talking about teleworking for the last 20 years. But what happened?
Organizations and their management teams became even more centralized, and urban centers grew. Companies and managers were reluctant to have their workforce go remote.
After all, managers felt they couldn’t control and manage their employees if they couldn’t “see” what they were doing all day long.
But now they’ve been forced to.
During the height of the pandemic, it was estimated that almost 6 out of every 10 Americans were working from home. And this trend will persist even after the pandemic passes.
Recent surveys have shown that nearly 40% of workers would consider quitting if they couldn’t continue working from home. And companies are changing shape as a result…
Last September, Pinterest forked over nearly $90 million to break its contract on a San Francisco office complex. It won’t need the space in a remote work environment.
Or consider e-commerce. Last year, many online retail categories showed a 74% increase in online orders immediately following the economic lockdowns. And now that consumers understand how convenient these services are, there is no turning back.
Popular grocery delivery service Instacart is the perfect example. Prior to the pandemic, it was valued at just $7.9 billion. Now? The company has exploded to an impressive $39 billion.
Let’s consider one more example. Peak usage of our wireless networks jumped 20–40% over a period of just four weeks during the lockdowns. These numbers are beyond crazy.
To put this growth in context, network data traffic would more than double every 12 months if this persists. We are talking about exponential growth.
But not all technology investments will be winners in the years ahead. In fact, some could crash hard.
So let me show you two warning signs to look for when considering whether to invest in a tech stock…
Stodgy Old Darlings
Our first warning sign concerns tech stocks that some consider “darlings.” They’ve been around for decades and seem like safe, solid investments.
But we shouldn’t let brand recognition trick us into investing in companies whose best days are behind them. Just because we’re familiar with a company’s products or logo doesn’t mean they’ve stayed on the bleeding edge of progress.
To be successful in the tech sector, companies must be innovative. Their product strategy and road map are critical. And they must improve people’s lives. At one point, every successful tech company was an innovator.
But some companies have simply lost touch. They got buried in their past success and fell prey to unnecessary processes and groupthink.
Some Silicon Valley “old guards” are trying to profit off their reputations from 20 or even 40 years ago… But they will be a black hole for investments.
These companies may even look like good “value” plays right now. But they are dangerous investments.
Or, put another way, there are far better places for investors to put their money.
Overhyped Tech Stocks
Our second warning sign is “hype.” Whenever we see news headlines blazing and hear chatter on social media, we want to be careful to not get swept up in the current of excitement.
While public enthusiasm doesn’t disqualify a stock from being a good recommendation, many stocks either don’t deserve the attention they’ve received or have gotten so much attention that their numbers no longer make sense.
In the past year, I’ve seen a lot of tech stocks trading at insanely high valuations…
These valuations are so high that even if these companies meet their aggressive growth assumptions, the stocks won’t rise much. This future growth is already priced in. And if these companies see even one misstep or market downturn, the stocks will plummet.
Even the best companies with technology that none of their competitors have are not good investments if they are trading at too high of a valuation. Investing at an irrationally high valuation in a fantastic company will still lead to losses.
For example, listen to the former CEO of Sun Microsystems, Scott McNealy, reflecting on his company’s overly high valuations before its stock fell 96%:
We were selling at 10 times revenues… At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends.
That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company.
That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero research and development for the next 10 years, I can maintain the current revenue run rate.
Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?
Sun Microsystems’ stock didn’t fall because it had bad technology. In fact, we still use its Java programming language today. It fell because the valuation was way too high at that time, in that market, to support its future growth expectations.
But while McNealy said an enterprise value (EV) to sales of 10 was ridiculous, we have to put these valuations in context. Back then, in those market conditions and with Sun’s growth profile, it was.
But today, some companies can justify an EV/sales ratio of 10 or more as long as they have the gross margins and growth rate to support it.
However, now we’re seeing examples that make Sun’s valuation back then look ridiculously cheap.
When cloud-computing software company Snowflake (SNOW) went public last year, for example, it was valued at an astronomical EV/sales ratio of 177. That valuation said the company’s worth was equivalent to 177 years of revenue.
That’s simply nonsensical. Investing at a valuation that high is a near guarantee that we will lose money.
I want all my readers to be on the right side of market history.
It’s been my mission to help my readers avoid pitfalls like these overhyped, overvalued stocks… and instead find life-changing gains with companies that have the potential to become the next Amazon.
And I’ve recently discovered one promising area of the tech sector where these kinds of gains are still possible… Where we can still get in early, like when Amazon first went public… and a $486 investment turned into $1 million.
I call these companies “Penny IPOs.” And in many cases, these companies allow us the chance to invest at even better valuations than the venture capitalists.
If you’re interested in learning more about this subset of small tech stocks that offer the chance for incredible wealth creation, then I invite you to join me at my upcoming event, Silicon Valley “Unlocked.”
You see, I’ve recently returned to Silicon Valley in order to investigate the top Penny IPOs out there. And I’m crafting my list… which I’ll unveil for attendees at the event on Wednesday, June 23 at 8 p.m. ET. I’ll even share my favorite private Penny IPO with everyone who tunes in.
You can go right here to reserve your spot.
I hope to see you there.
Editor, The Bleeding Edge