In our previous blog, we talked about how investing in emerging markets can create superior returns for investors in the longer run. In this blog, we will narrow our focus in the emerging markets towards a segment that is one of the fastest wealth creators for the past two decades. This segment has generated the most number of billionaires in the Forbes List and was the quickest to recover in the ongoing pandemic- The technology sector.
Investing in Technology:
The technology sector has mystified several investors across the globe. The prospects of finding the next Amazon or Apple or Microsoft creates a massive drive among investors to look for companies with this potential. Unfortunately, they forget that the “Get Rich Quick” attitude towards investing usually means “Get Poorer Quicker.” A sound analysis of the company and likely scenarios must be done before concluding investing in the company. Some of the pointers I specifically use for investing in a technology company are:
- Utility- The utility of the technology is perhaps one of the most critical factors in determining the success of the technology. The technology should add value to the user, and it is essential to see how that technology could become a part of the person’s life. If the technology meets these criteria, it is an investible technology.
- Commercial Viability- No matter how promising the technology is, it is bound by the rules of economics and markets. The technology must be commercially viable to produce and must sell at an attractive proposition to the customers. The profitability of the technology must play an essential role in determining the investment decision.
- Company- With all the utility and commercial viability, if the management of the company does not have a proper vision and execution towards the goals, the company is unlikely to thrive in the competitive scenario.
Investing in a Company:
Once an investible technology is identified, investors are faced with the mammoth task of recognizing that one company that will become the market leader in the segment and generate returns for the shareholder. It is recommended that in the current scenario, investors invest in futuristic technologies like the IoT, Artificial Intelligence, Cloud Computing, and Blockchain as these will be the likely key drivers of growth in the decade forward. Apart from that, I also recommend that investors look at the following metrics to identify companies that will generate higher returns than their peers:
- Barriers to Entry- In the technological segment, barriers to entry play an essential role in determining the long term advantage of the company. For ex- A patent or dominance in a particular sector can generate high returns on invested capital.
- Cost Advantage- In technology, cost advantage plays a detrimental role in the margins of the company. If the company can attain a cost advantage in manufacturing or the labor segment, costs go down rapidly, allowing the company to capitalize its earnings and deliver higher returns than the peers.
- Product Loyalty- Superior technology can create a high level of product loyalty by customers towards the company. If the company continually comes up with extensive features that enhance the use of the product for the customer, it translates into the longevity of the company and the loyalty of the consumer base.
- Service Eco-system- Superior product is not the end of the road for technology companies. They must create a whole eco-system of their services so that the user can blend in their products and culture. A service eco-system can also add value to their products, thereby increasing their popularity among the users.
- Financials- Financials form an integral part of the analysis of technology. Since technology companies are asset-light traditional valuation metrics, they usually don’t work very well. The focus must be on free cash flows generated and the bottom line of the company with specific importance to growth in these variables. If the company is in loss, a trend analysis must be done to find out whether an increase in revenue is causing a decline in the loss reported. This can potentially identify a company’s strategy towards a break-even point and can give the investor a timeline for profitability.
Case for Indian Technology Companies:
The technology sector in India is one of the most rewarding and high growth areas for investment. The industry in India is dominated by IT companies who provide services to clients all over the globe. This has made the Indian IT industry one of the most booming industries in the world.
One of the main advantages that India has over other countries is the cost of labor. The cost of labor is significantly lower for the quality of IT professionals India produces. This creates a favorable scenario for global companies that can typically outsource in India at relatively lower costs. Indeed, due to this reason, technology companies in India have seen massive growth in the past two decades and continues to grow at a decent rate.
Future of Technology:
The pandemic has made it clear that technology has now become an essential utility, just like FMCG and telecom. Hence it is clear that technology will be a trend in the next bull market. An investor looking to benefit from technological trends must invest in communications and futuristic technologies like blockchain, cloud computing, etc. Fintech is also one of the most promising fields to watch out for, as the massive financialization of savings in this decade will most likely take place via fintech technologies designed for millennials. One must also focus on gamification in technology as a theme to build attractive UIs for millennials, as this can be one of the most attractive value propositions to enhance the user experience for the next generation.
By- Akshay Vyas