Investoid

Jim Oberweis of Oberweis Asset Management wrote an article in Forbes last week about what to look for in tech stocks. Here are the main points:

• Distruptive technology
• Double digit net margins
• Revenue/earnings growth of at least 30%/year
• High marginal profit margins
• Barriers to entry through proprietary property or exclusive agreements
• A PEG ratio of less than or equal to 1

I think this is a pretty good set of tech-specific screening items, although I would expand his barriers to entry definition to include business barriers to entry such as a high initial investment required, a dominating market share (eg. Google), or high switching costs.

In general I am interested in small tech stocks because of my software background. Otherwise, I would probably avoid them since they do not fit into a value style of investing. Like investing locally, investing in growth technology stocks requires you the believe the story and believe management can execute. With that in mind, here are some more points to help you evaluate tech stocks:

• Cash Flow: Tech stocks can be the most notorious stocks for special charges, ‘one-time’ items, and the like. Earnings are always a good place to start looking, but if the company isn’t operating cash flow positive take a look why. If it doesn’t look like the company can generate positive cash flows in the near future, take a pass.
• Dividend: Most tech companies don’t pay a dividend since they are early stage and need to keep their retained earnings to fund future growth. If the tech company you’re looking at has a dividend, you need to revisit its growth potential.
• Intangiable Assets: If I see a lot of intangiable assets on the balance sheet (particularly goodwill), I get a little worried. If there’s a lot of goodwill then they likely paid handsomely for some other companies or some intellectual property. Unless I know exactly what those purchases are and how much they paid for them, I would be worried about the utility of these assets and the possibility of future writedowns. If such assets are not well disclosed in the financial statements or additional investor relations documents, then it is a cause for concern.
• Options: Make sure you take a look at the option grants being given to management and employees (particularly if it’s a US stock). If there are many options as a percentage of current oustanding shares, then you risk being greatly diluted as the company grows. However, if there is a reasonable number of options currently outstanding, there have been more options recently granted and the company’s earnings are already growing at a strong pace, then expect an additional earnings boost in the future since US stocks have to expense options now when they are granted.

Investing in tech stocks can seem exciting, but at the end of the day you need to take the same steps as you would with any other stock.