How to invest in technology shares - GARP and his world

Even if you did not think about it yourself, you're probably a GARP person. Most are, maybe all really. GARP stands for Growth at A Reasonable Price. The GARP Growth Component makes time work for you in an investment, extending the range of what is perceived as a reasonable price. In contrast, Deep Value strategies in shrinking or even dying companies depend on relatively imminent liquidation to provide positive returns. In addition, reasonable price is limited to a fair bit below the tangible assets. If you are not yet 40, you may not even have come into contact with genuine Deep Value strategies.

Investment strategies targeting Dividends, Value, Growth or Tech can actually all be categorized as GARP: Growth at a reasonable price. If the price were unreasonable, no investor would be interested, although some categories of speculators would like to throw themselves on the buy button if the tea leaves (price graph) show the correct pattern. And without any growth at all, regardless of whether it is higher or lower than average GDP growth, rarely even orthodox dividends or value investors are interested. With a growth in sales, profits, dividends or cash flow that yields valuation multiples (in 2023, for example) within a few years, with an implicit return on at least risk-free interest, everyone is gathering around GARP. If it is a dividend yield or FCF yield of 5 percent, a P / E ratio of around 20 or P / S of 2 is of less importance. The point of GARP is that any amateur can clearly see how the investment produces better results than just spending money.

However, growth stocks and the technology sector often show even greater potential.

Indeed, a GARP investor's ultimate investment object grows unusually fast, exhibits economies of scale in manufacturing, distribution, branding, technology and investment capacity, and extends its lead to competitors and further strengthens its position in line with growth. In addition, the company should be ”cheap” according to some fundamental valuation measures, even if it is based on forecasts of key ratios for several years to come. The "Techs" works periodically as a magnet for a little more rico-tolerant GARP supporters.

A few years into a stock market rise, the technology sector is increasingly attracting optimists. Risk tolerance increases with the number of years of upturn. At that time, companies in the sector have convinced investors about the firm's high growth rates, strong competitiveness, as well as economies of scale and cash flow conversion (cash conversion, ie, how much of the reported profit is actually available in the form of free cash flow - especially software companies tend to be good at this ). At the bottom of a stock market cycle, many are skeptical of stocks, but soon, everyone wants to join the party. At the end of the cycle, an ever smaller group of fast-growing technology companies will gradually become the obvious way to maximize return on capital. Today, it's the FANG shares, but nothing says it's just information technology that should attract interest. It might as well be biotechnology or pharmaceutical companies.

Around the year 2000, network and telecom companies like Cisco and Ericsson attracted the most extreme interest from investors. Now there are different varieties of social media and retail in focus. Previous cycles include railway technology, radio companies, PC manufacturers and software companies.

But how do you really define a technology company? Why are Facebook, Apple, Amazon, Alphabet and Netflix considered technology companies, while Electrolux, Atlas Copco, Sandvik and SKF are not (longer)? And what about Volvo, General Motors and Tesla? Just to drive home the point all the way, how do you see Telia today? Or Johnson & Johnson?

The most practical definition of a ”technology company" is that the handful of stocks with rapidly growing market caps on the stock exchange are technology companies, regardless of their actual business or methods and tools to drive their business. Yep, it's just as stupid as it sounds. Why would otherwise serious investors group the rental video and television series production company Netflix together with Alphabet, which manufactures robots, Internet search software and AI with communication platforms like Facebook and Twitter, retailers like Amazon and Alibaba, as well as car companies like Tesla, but exclude real technology companies like General Electric? And why should pharmaceutical companies be excluded?

What is your own definition of technology and how is it intended to improve your investment decisions in practice? How, for example, do you think about a company like Intel, which manufactures the most advanced technology products available and uses the most advanced tools in the manufacturing process? Objectively, nothing is more "tech" than Intel.

But, as a technology investor, you obviously want to have a bookstore, a search engine that sells ads, a metal working company (Tesla), and a company that can annoy you on with other people's nice holiday pictures.

A strategy that can work for smaller investors is to follow the herd in this self-reinforcing process, where the winner is defined as technology company and thus attracts even more capital and thus becomes even more of a winner. Another is to think for yourself what it really is you are looking for. Of course it can be profitable to run with the flock, it is usually correct, but it will be even better in the long run if you at the same time have a perception of the reality actually, in order to determine when the price has become completely unreasonable.

A healthy value investor wants growth at a reasonable price, but it is not what he gets due to the following typical development: Technology companies often imply an additional risk, a risk that sometimes but not always (then it would not be a risk) provides dividends in the form of higher growth and a temporary monopoly position with high profitability. At the beginning of a cycle, due to risk, pricing is often so cautious that it only takes into account a few years of super growth. After a while, risk appetite increases and investors extrapolate more and more years with both high growth and profitability. In the end, the technology annotation turns almost magical and all companies want to be associated with the sector in one way or another. Investors who see "everyone else and their dogs" get rich in technology investments are driven by a fear of being the last fool to realize the paradigm shift, and therefore accepts that whatever is called technology is also. Unfortunately, capital flows make many companies unreasonably highly valued and do not meet the GARP criteria at all. Many times, companies also show neither high technology content nor reasonably priced; They may not even grow but implode when they could only exist thanks to virtually free access to venture capital.

Define clearly for yourself what the purpose of your investment is and what you have for your requirements. Probably, there is a large available market (TAM = Total Available Market), a production with economies of scale and ability to grow fast (preferably free unit cost and second-rate "manufacturing" as for software companies), a difficult and ever-increasing competitive edge (like Intel, whose factories next generation processors require greater investment for each time as well as the skills of the previous generation). Size potential, potential growth rate, competitiveness, cash flow conversion and lock-in effect on customers are probably what you want, but if you just follow the flow of investors in "technology companies" you risk getting something else.

Smart-oriented innovation in any company brings benefits that can create powerful value creation. However, it does not matter if technology content is manifested in the final product (Intel), user analysis (Facebook), production process, distribution or degree of addictive (betting, computer game) and customer satisfaction (Apple). The main concern of the investor is that innovation brings about a lasting value in the form of sustainable cash flow generation.

An example of smart innovators is Spotify, which is not considered a classic technology company; they distribute music. On the other hand, the company creates creative and addictive music lists as well as enables artists to analyze audience preferences and tailor song production accordingly. Spotify is a big data company that gradually connects both customers and manufacturers to the network, even though the end product is "just" music and radio.

A cautionary example is the car company Tesla, which currently consists of a rudimentary electric motor and standard battery with an unsophisticated casing. The level of innovation is nonexistent, but Tesla was out early, and the first acceleration experience in a car with a strong electric motor is hard to ignore, even though the drive line quickly overheats and becomes almost unusable after just a few minutes of maximum power. Is Tesla a technology company? No, neither the final product nor the production process has any significant technological height or competitive advantage. On the other hand, the technology stamp in itself, albeit unwarranted, and the early start of the share has become a technology asset, so from a stock market perspective, Tesla is still a de facto "technology company". Those who early realized the potential of the stock, regardless of the insight into the business, which mainly involves the production of sharps, tweets and debts, has received very high returns.

As always with investments, make some effort to get to the core of the matter. The conclusion is not to uncritically buy the tech designation without defining what you are looking for and then finding it. Today, many corporations categorized as technology companies have long left GARP territory and hover over the zero interest rates in La La land. Make your analysis of their situation thoroughly and clearly define the basis for your strategy before investing in or shorting their shares.