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TechTalk -- To Infinity and Beyond!

By Stuart Watson (TMFTiger)

Welcome to the first article in our new weekly series looking at technology. Each week we'll be focusing on some of the latest developments, or perhaps taking a closer look at one of the stock market's rising stars. Think of this as technology Fool's Eye View. So this will be the central point for articles discussing such topics as Bluetooth, business to business e-commerce and 3G, the next generation of mobile phones. In accordance with the Foolish philosophy we will attempt to break through the jargon and present the issues as clearly as possible.

But before we get started let's think about what we are looking at here. What is technology? How should we define a technology stock? A dictionary definition of technology is "the practical use of scientific knowledge in industry and everyday life". I'd say that covers pretty much everything. Maybe we should be saying "what isn't a technology stock?" In fact one of the founders of the Motley Fool in the US, David Gardner, often says that the terms Internet stock and technology stock are outdated. Why should we pigeonhole our investments into neat little categories? Every company is different, having its own unique strengths and weaknesses.

Or perhaps a few quips and quotes will help us get started? How about "technology enables (wo)man to gain control over everything except technology"? Or perhaps "technology is rapidly filling our homes with appliances smarter than we are". The latter is certainly true in my case. Only last week my toaster trashed me at chess using a cunning, but little known, opening gambit.

But down to business. Investors like 'technology' stocks because they can offer returns far in excess of the market average. Traditional manufacturing companies are often restrained by capacity and heavy capital expenditure needed to just to stand still. But software companies can produce vast numbers of additional copies of their products at a minimal marginal cost. Hence the high profit margins and returns on capital often earned by such businesses. Of course there has to be demand for the products as well. As an example of the potential returns, have a look at this tasty trio:

	Floated	Price at Float	Price at 5/1/00	Annual Return
Sage	Dec 89	2.6p	658p	73%
Logica	Jun 89	27.3p	1380p	45%
America Online	Mar 92	$0.09	$74	135%

Given that the long run return of the stock market as a whole is in the region of 12% these three have whipped the average by a significant margin. All three are arguably overpriced by most conventional methods of valuing shares. For example Sage (LSE: SGE) is priced at 125 times forecast profits. Considering that it has grown at slightly less than 35% per annum over the past few years this looks a little excessive. But even if the shares were valued at just 25 times forward earnings the annual return over the last ten years would still come in at around 48%.

Can we expect these companies to continue growing at these sort of rates? If Sage's share price carried on growing at the same rate it would be worth over £120b in five years' time. Today that would make it the largest company in the UK.

It is all very well highlighting the winners, but for each of these there will be many losers. Say that ten years ago you invested £1,000 each in ten companies. One of them happened to be Sage but unfortunately the other nine were complete turnips, went bust, and you lost all your money on every single one of them. At the end of the ten years your initial pot of £10,000 would have become £240,000. That is still an annual return of over 35% a year.

There has been a lot negative press about tech stocks recently. Private investors 'getting burnt' and finding out the 'harsh realities of the stock market' are common themes. But if you are a long term investor who bought ARM Holdings (LSE: ARM) back in early 1999 or even 1998, as many Fools did, such comments seem a little churlish.

Investors in these sort of companies know they are in for a rocky ride. For example on Wednesday, Amazon.com (NASDAQ: AMZN) fell 15% after it released preliminary figures for the last three months of 1999. And BMC Software (NASDAQ: BMCS) fell 36% after issuing a profits warning. Earlier in the week the Dutch software company, Baan, dropped some 30% after it warned of increased losses and its Chief Executive Officer resigned. But such risks are not unique to tech stocks. In fact perhaps it is more risky to invest in traditional companies that are in danger of having their market positions wiped out by new developments. Perhaps it is these companies that are overvalued?

Here at the Motley Fool we have a unique opportunity to identify some of the best companies to invest in over the long term. Among our posters we have a mix of people who understand the technology and those who understand the financial side. Bringing these two together and added a sprinkling of good old common sense as well, we should have a winning recipe. Unlike the financial institutions we can set our own time frames and objectives as well. So let's get busy. A prosperous 2000 and beyond to all Fools!

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