How to benefit from the tech boom without buying the craziest stocks

The tech sector is starting to look very frothy indeed. But you can play it without buying the most bubbly areas, says John Stepek. Here's how.


Tech stocks: be wary of the hottest sectors

The Nasdaq America's index of tech stocks has hit a high not seen since February 2000, reports James Mackintosh in this morning's Financial Times. In March 2000, as many of you probably remember, the tech bubble burst.

That perhaps doesn't sound that scary. After all, it's taken 14 years for the tech index to get back to this level.

But as Mackintosh points out, the number of companies trading on extremely high valuations is also at its highest level since the dotcom crash.

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There's no doubt about it the technology sector is looking frothy.

But is there a way to play the sector without buying into the most bubbly areas?

Humanity's great advantage we can learn to take anything for granted

One of the great things about human beings is our extraordinary ability to become accustomed to almost anything.

On the one hand, this trait lends some nations and individuals the strength to tolerate and cope with situations that might seem intolerable from the outside.

On the other, it also means that we eventually learn to take for granted even the most astounding advances and privileges.

That might not sound very helpful. It's not conducive to a contented state of mind. Stopping to count your blessings regularly is a good way to stay grounded and hang on to some sense of perspective.

But it also means that we never stop striving to make things even better.

To see what I mean, you just have to look around you. In many ways, we live in an age of wonders.

Smartphones that give access to almost the entire sum of human knowledge at your finger tips. The ability to communicate with almost anyone, almost anywhere in the world, instantly and at low cost. Advanced technologies like the electric car on the verge of breaking through.

Look at the problems that we complain about. Serious columnists in serious newspapers devote entire pages to worrying about what we'll all do when the robots replace us.

Think about that for a moment. One of our genuine big fears at the moment is what we'll do with ourselves when we've created a class of automatons that will uncomplainingly do all our work for us.

Yes, it's a complicated issue to grapple with. A lot of it boils down to how wealth ends up being distributed in that sort of world. But it's not the worst problem to have.

Stories are great but valuations matter a lot more

What's all this got to do with investment? Well, I'm making this point because I want to acknowledge that there is a lot to be excited about out there. These are exciting stories, and a lot of them will come true.

Just look at the internet. It's become integrated into our lives in way that even the most excitable tech pioneers of the late 90s might not dared have hoped.

And in ten years' time, we might be scooting about in self-driving electric cars, complaining about how the drone delivering our groceries always picks out bananas with bruises on them. Stranger things have happened.

Trouble is, just because a story sounds great and might even be true does not always make it a great investment. In fact, often it's the exact opposite.

Investors love a good story. It gives you a reason to buy a stock, and a reason to dream. And companies that have good stories behind them are often at a very early stage in their development. So you can pluck whatever numbers you want out of the air to justify their ever-rising valuations because it's all predicated on a rosy future scenario.

But that's pretty much the opposite of sensible investing. Warren Buffett and the value-investing brigade always emphasise the importance of a margin of safety'. That is, you need to have a good idea of what you think a stock should' be worth, and then you only buy it if the stock is selling at a good discount to that value.

If you have very little clarity on a company's future earnings, how are you meant to even get an estimated value, let alone figure out if there's a margin of safety' there?

Be wary of the hottest sectors

This is why I'd be very wary of the hottest sectors out there. I'm not saying that you should sell all the hot stocks you own if you're riding the bubble already then there's no sense in trying to predict exactly when it will end. However, I would consider putting in stop losses (even notional ones price points where you'd revisit the case for holding, rather than specific orders with your broker) to lock in at least a chunk of your gains for when and if things turn nasty.

As for other ways to invest in the tech boom there is a fairly boring sector that provides something that all of the sexy stories, from smart grids to social media to internet retail, all need. And that's security.

The more of our lives that we live online, the more vulnerable we'll be to cybercrime and the more reassurance we'll need that our communications and finances are secure. While the companies involved aren't trading at rock bottom valuations, nor are they quite as wildly expensive as the most speculative stocks in the field.

If you're looking for a way to benefit from the ongoing technological boom, I think this is a good picks and shovels' sector to focus on and handily enough, my colleague Matthew Partridge has looked at the sector in the latest issue of MoneyWeek magazine, out tomorrow. If you're not already a subscriber, you can get your first three issues free here.

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John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.