Posted March 06, 2023
By Zach Scheidt
Please Don't Misunderstand… Not Every Tech Stock Is Garbage
I'd like to clear the air and correct a misunderstanding.
You see, I may have accidentally implied that I'm opposed to technology stocks or that all tech stocks are dangerous.
The truth is there are plenty of tech stocks that can help grow your retirement wealth.
But there are also quite a few tech stocks that could destroy your savings, especially if you don't have a balanced investment approach.
So today, let's take a dive into the technology sector and look at what separates the winners from the losers.
It's All About Valuation
When I look at the way today's tech stocks are trading, I pay very close attention to valuation.
This is a concept that got drilled into my head as a hedge fund manager more than 20 years ago.
"Always know what you're paying for." That's the phrase I heard over and over from one of the seasoned traders down the hall.
You already know that when you invest in a stock, you're buying a small piece of a business. But how do you know what a fair price for that business should be?
The best way to come up with a reasonable price for a stock is to look at the company's earnings per share, which tells you how much profit the company makes for every outstanding share.
I like to look at future (or expected) earnings per share because this tells me where the company is headed. Future expectations are much more important than what a company has done in the past.
You can look up a company's expected earnings per share through any number of free online resources like MarketWatch, Yahoo Finance, or Google Finance.
The next step is to look at a stock's current price and compare it to the expected earnings per share. Here are a couple of examples…
If a company is expected to earn $10 per share and the stock is trading near $100, you're paying 10 times expected profits to invest in this company.
If a company is expected to earn $2 per share and the stock is trading near $150, you're paying 75 times expected profits to invest.
Generally speaking, paying less for anything you buy is a better value. But of course, there are reasons you might be willing to pay more.
For example, you should be willing to pay a premium price for a company that grows profits quickly.
Or you may want to pay more for a company with less risk because they don't carry debt or have an advantage over competitors.
This brings me to the current market for tech stocks.
Many Tech Stocks Are Too Pricey…
The most dangerous tech stocks in today's market are the ones that trade at high valuations.
That's because if fear returns to the markets, investors will bail out of these names first. Since prices are high compared to profits, these stocks have a long way to fall.
You can find many of the most vulnerable stocks in the popular ARK Innovation ETF (ARKK), a fund managed by the infamous investor Cathie Wood.
Here's a snapshot of the largest holdings in this fund, many of which are on my short list of stocks I expect to fall sharply.
While some of these names are investor favorites and have run sharply higher this year, please be careful.
Many of these stocks simply don't deserve the rich valuation the market is currently giving them.
While Other Tech Stocks Are Reasonably Priced
Meanwhile, there are still plenty of high-quality tech stocks that I would love for you to invest in.
Apple Inc. (AAPL) is one of the names I recommended years ago through my Lifetime Income Report dividend service.
The company is famous for its iPhone product line. But some time ago, Apple began to transition away from simply selling products and now generates much of its revenue through subscription services.
If you buy the stock today, you’re paying about 26 times expected profits for this year. And while that's not a cheap valuation, it's very reasonable considering Apple's profit growth and reliability.
Another tech name to consider is Google's parent company Alphabet Inc. (GOOG).
While mega-cap tech stocks like GOOG traded sharply lower over the past year, there's actually a lot of value in a few of these names.
Google's ad business continues to be strong, and Wall Street analysts expect the company to earn $5.11 per share this year.
If you buy shares today, you'll pay just about 19 times expected profits. Again, it's not a cheap stock by any means.
But given GOOG's reliable profit and expected growth, there's plenty of room for shares to move higher.
Finally, I'd love for you to take a look at the tech stock Adobe Inc. (ADBE).
The company's software helps with digital media creation and also offers online marketing solutions. These services are very important in today's increasingly online economy.
Best of all, ADBE generates reliable profits that continue to grow. The company is expected to earn $15.28 per share this year, which means investors are paying roughly 33 times expected profits.
That's a reasonable price to buy shares of a company that is growing profits in an important area of the global economy.
So when it comes to tech stocks, there are plenty of great opportunities for you to grow your retirement wealth.
Just please be careful to invest in companies that are growing profits. And don't pay an arm and a leg to own those shares.