For most of the last two decades, investors have been enamored with technology. I am baffled to understand why. Why do these companies trade at such hefty multiples? Why is there so much excitement? For the most part, technology is an awful business to be in.
What’s good about the business? When things are good, there are strong margins, rapid growth phases and a certain buzz about the products. As humans, I think we instinctively like progress. Technology is progress. We want to like these companies. We want to believe. Successful tech companies can come to dominate parts of the economy that do not yet exist. If you get it right, you can get it VERY right. Everyone wants to find the next Microsoft or Nokia. Unfortunately, those winners are rare. Some people like to gamble. Not me.
What makes technology such a tough business? To start with, there’s an amazingly short product cycle. Some new technology almost always replaces the last invention. This means that you have to conceive a product, produce it, market it and sell it before someone else comes along with something better. In technology, this window is normally measured in months. This makes business execution difficult. Fumbles are frequent.
Even if you have a hot product and you have big profits, shareholders rarely see those profits. Earnings are plowed right back into research and development. Will the next product be a success? Will it flop? No one knows and it’s very expensive to find out. If you get it right, your company survives a few more years. If not, you burn out fast. Without a new hit product, it’s hard to get enough capital to research the next product. Once you fall behind, it’s nearly impossible to catch up to the competition. History is replete with companies that had a few successful innovations, then missed a product cycle and collapsed.
Tech companies are like burning matches. There’s an occasional flare up. You want to catch that—you do not want to still be holding the match when it burns down to your fingers. If these things were priced like pending bankruptcies, maybe it would make sense to sort through and figure out which products have potential. Instead, for most of history, tech companies have been priced like they will be successful in their endeavors.
Of course there are always innovators. There are great investments to be made by those who can see the future. I just find it too hard. Even if you guess right, a larger tech firm will simply use extortionary tactics when buying out your favorite company. Larger tech companies let smaller guys waste the money on R&D. If a product has legs, it gets bought out. That just makes it all too hard. No upside if right—plenty of downside if wrong.