Let me tell you about three people, each with a net a worth that rivals some cities or even small countries.
Each of them millionaires by 25, billionaires by 30.
Their names? Larry Page, Evan Spiegel, Mark Zuckerberg.
How did they make their fortunes? With technology.
It’s no longer a surprise to hear that some young-buck tech freak has developed an app or website that’s on its way to making its first billion. Evan Spiegel did it in two years. From 2013–15, he went from millionaire to billionaire thanks to his app, Snapchat. But if you think that the colossal gains that have emerged from the tech sector have been and gone, you’d be sorely mistaken.
Only the start…
The truth is the tech booms we’ve historically seen are only the start. Driverless cars, artificial intelligence (AI), virtual reality, blockchains, and drones. As computing power and peoples’ need for it increases, so too does the number of companies that could put a rocket under savvy investors’ bank balances.
However, tech investing comes with high risk, along with its high potential returns. Getting in early with the next big thing could mean life-changing investment returns. But if you get it wrong, and your speculative tech investment isn’t everything it promises to be, your investment can quickly turn to nothing.
As well as the individual risk, the technology sector as a whole can be a dangerous place for investors. The dotcom boom and bust is the perfect example. If you don’t remember the five years from 1997–2002 and the massive, ubiquitous share declines that came with it, we’ll give you a quick refresher now. It’s a story anyone looking at tech stocks should keep in mind.
To tell that story properly, we must go back, briefly, to 1982. Larry Smarr, a computer scientist, realises that US universities are facing a supercomputer drought after being forced to go to Europe to complete some research. In response to this shortage, he wrote a 10-page proposal urging the National Science Foundation (NSF) to fund and create a supercomputer centre. His wish was granted, and from 1983–85, four such centres were developed in Cornell, Princeton, San Diego, and Illinois.
Seven years after the inception of NSF’s Supercomputer Centres Program at the Illinois facility, a team of computer scientists were working on a web browser that could support multiple internet protocols. Their result was Mosaic. Due to its reliability, ease of installation, and intuitive interface, it was quickly adopted as the go-to web browser — acquired by Microsoft shortly after in 1995.
Thanks largely to Mosaic, by 1997, computers, and the internet in particular, went from the realm of wealthy geeks to everyday consumers. Being connected was now more necessary than ever. As the internet became more popular, so too did the websites that existed on it. Almost overnight, these sites surged in popularity, leading investors to believe that a new, booming market was about to emerge.
This excitement coincided with the 1997 Taxpayer Relief Act, which lowered the highest marginal capital gains tax and allowed investors the confidence needed to make more speculative investments. The coupling of these two events paved the road for what would later be known as the dotcom bust.
Investors were essentially throwing money at new websites in the hope something would stick. Sites that had never turned over a profit and had no discernible reason for existence to investors were suddenly graced with massive stock valuations.
This blind-faith style of investing remained the trend up until 2000. The only time investors showed any semblance of caution came in the months before the new millennium, but this was only because of the Y2K problem (I’m sure you remember that one).
When Alan Greenspan (then the Chair of the Federal Reserve) raised interest rates aggressively in February 2000, investors were unsure whether or not tech stocks would be affected by the higher borrowing fees. In March 2000, the Nasdaq reached a (then) all-time high of 5,048 points. Just three days later, after news of Japan’s recession, people started selling — especially tech stocks.
A week after the Barron’s cover article, ‘Burning Up; Warning: internet companies are running out of cash — fast’, warned that many websites were running headfirst into bankruptcy. This article shook investors, and some companies saw massive share declines; MicroStrategy’s share value falling from $333 to $120 in a single day.
A few weeks later, in April, Microsoft was found guilty of monopolisation, leading to a one-day 15% share price drop. Throughout the following year, many internet companies faced massive downturns. Pets.com, valued at $11 per share during its February IPO, was worth just 19 cents by November 2000.
At this point, the majority of tech stocks had seen, on average, 75% share declines. 2001 was an even worse year for tech stocks, compounded by the 9/11 attacks. By October 2002, the Nasdaq was down 78% from its peak…
Are Tech Stocks Vulnerable to Hype?
Any sector of the stock market is vulnerable to hype. But as the dotcom boom demonstrated, tech stocks can be particularly vulnerable to over-optimism about the future. This is likely because so much of their value is built on just that — the potential of the future. Despite all those risks, the speculative end of the tech sector is still one of the best places to find life-changing investment returns.
When you think of tech stocks today, you’re probably thinking of the FAANG stocks. That is Facebook, Apple, Amazon, Netflix, and Google (technically Google’s parent company, Alphabet). While these are undoubtedly five of the biggest tech stocks, the one thing they all have in common is the internet. Without it, not one of these companies would be where they are today. That’s not to say the internet’s going anywhere or that some of the biggest earners in the future won’t have anything to do with it, because it’s not and they will.
Though being directly linked to the internet is no longer a prerequisite for a tech stock to skyrocket. It’s not just apps and websites that are raking it in.
Take a company like DJI, for example. In 2006, Frank Wang was granted US$2,300 by the Hong Kong University of Science and Technology to research and develop a new type of remote-controlled vehicle. From his dorm room, he started his company, DJI, and less than 10 years later, his flagship vehicle, the Phantom, upended the aerial photography sector. The remote-controlled vehicle? A drone. DJI’s control over the drone marketplace? More than 50%.
It’s easy to see how quickly a new technology can reroute any given sector’s course, and how much of an advantage the frontrunners have over the latecomers.
However, tech stocks are highly speculative. The old adage, ‘only invest what you can afford to lose’, is especially true when dealing with tech stocks that are inherently risky. And the extent to which you invest in this sector is subject to your appetite for risk. But as I’m sure you know by now, this is the sector where some of the biggest gains could be found if you get it right and get in early.
If you’d like to know more about technology investing, you’re in the right place. Our editors often cover the latest from the tech sector and much more in Money Morning’s daily updates. You can read more here.