4 tips to pick tech winners
Focus on market size, efficiency, growth and management.
In January 1962, an executive from Decca Records in London, Dick Rowe, famously turned down an offer to sign a recording contract with The Beatles, offering the opinion that “guitar bands are on the way out”. The Beatles went on to be the best-selling pop group of all time and generated billions in revenues for EMI, the record company that did offer a contract.
Even today, 46 years after the band broke up, annual royalties on The Beatles’ record catalogue is estimated to generate more than US$70 million a year.
As a technology analyst with Morgans Financial, I am faced with the same challenge as Dick Rowe in 1962: picking winners. Out of a crowd of hundreds, I try to pick tomorrow’s technology super-bands.
Sometimes analysts get it right. Sometimes we make mistakes and fail to identify the next big thing. However, as a tech investor you don’t have to pick every winner; you can make good returns in the tech sector by avoiding companies with little hope of success and holding on to stocks that keep delivering.
Using those principles, on average I have made good money for myself and those who have followed my stock picks.
Australia produces a vast number of new technology start-ups. Thousands get off the ground each year, mostly funded by the entrepreneur’s savings, credit cards and loans from friends and family.
Unfortunately, 80 to 90 per cent of them fail, due to the normal list of problems that beset early-stage companies – the “revolutionary” technology was never that revolutionary in the first place, management lacked the ability to manage, or they ran out of money before they could get off the ground.
Of those that do survive, around 10 to 15 companies will make a run at the big time, raising large amounts of money to pursue their dreams by listing on ASX or, in some cases, by obtaining venture capital funding from Silicon Valley in the US. Out of the group of new technology listings each year, probably one or two will emerge with a real business generating significant cash flows.
Notable Australian tech success stories have included REA Group (worth about $7 billion today), SEEK ($5 billion) and Carsales.com ($2.5 billion).
Choosing great tech companies
There is no single set of rules for determining success in the tech sector. However, there are a few simple rules of thumb that I use to select companies to invest in. In no order, they are:
1. Market size
For a tech company to deliver outstanding returns, the addressable market must be large – hundreds of millions of dollars at the very least. The risks and start-up costs for new tech businesses are the same if the addressable marketplace is $50 million or $5 billion. However, a larger marketplace has more room for new players and the eventual rate of return upon success for the new business will be defined by the size of the prize.
2. Genuine improvements in efficiency
For an emerging tech company to become the new market leader its technology and products must deliver outstanding improvements in efficiency for the end users, the customers. To get a handle on efficiency gains I normally spend a lot of time talking to customers who use the technology in their daily business.
My big questions are a) has this improved the way you do your job or is it a far better experience than anything else on the market?; and b) has this technology saved your business money in the past three months? If the customers using the technology are luke-warm, I lose interest.
(Editor's note: Do not read the following ideas as stock recommendations. Do further research of your own or talk to a financial adviser before acting on themes in this article)
Recently I was asked to publish research on a small technology company, LiveHire Ltd (LVH), which developed an innovative way for large companies to improve hiring efficiency through the creation of “talent communities” of current, former and prospective future employees.
Initially I was sceptical because there were many new employment technology firms coming to market. However, after speaking to five long-standing users of the LiveHire technology – one of whom was saving $1 million a year on hiring costs – I decided the company was worth further investigation.
Since then LVH has listed on ASX and has almost 100 paying corporate customers. There is still a long road ahead for LiveHire – it needs to grow the customer base five-fold to reach profitability – but the early signs are promising.
3. Growth metrics
For some consumer-facing tech businesses, speaking to users is not possible. For so-called B2C (business to consumer) companies the best way to measure performance is by using online usage data, such as the number of consumer visits to the website each month, the number of page views each month, the average time spent on the site, the “bounce rate” (the percentage of people who visit the site and view just one page before going to another website) and the “conversion rate” (the percentage of visitors to a site who engage in a transaction).
Unfortunately for most investors, this data is expensive to obtain, but investing in tech stocks without good monthly metrics data is like trying to land a jumbo jet while watching the rear-view mirror. Some pubic data can be gleaned from websites such as Alexa and Similarweb.
In my experience the best online businesses show strong and consistent year-on-year improvement in the monthly number of page views and show a low or steadily reducing bounce rate.
Companies with high bounce rates are either buying a lot of cheap traffic to give the appearance of success where none exists, or have a high percentage of consumers who have used the website before and have had a poor experience – hence they bounce off the site immediately after seeing the corporate logo. I have never seen a company with a persistently high bounce rate thrive in the long run.
4. Management experience
Mistakes are easily made by first-time entrepreneurs as they are doing everything for the first time. However, having a seasoned industry executive or two with a history of tech-related start-ups will reduce the number of early mistakes and greatly increase a company’s chance of success.
Back in 2010, former REA Group executives Simon Baker and Shaun Di Gregorio joined the board and management team at iProperty Group (IPP), a struggling real estate portal focused on South-East Asia. The former management of the company were well intentioned but had no experience.
Di Gregorio had been REA’s chief operating officer and knew exactly how to run a leading real estate portal. Once he assumed the role of managing director there was a consistent improvement in quarterly results as IPP had started doing more of the right things and stopped making mistakes.
The injection of experience took IPP’s market capitalisation from $30 million in 2010 to $750 milllion when it was acquired by REA in 2016.
Had the company not enjoyed an injection of experience, the outcome could have been dire.
Sometimes it is not possible for an emerging tech company to find the right mix of skills for its board. But as an investor you are always in a less risky position if there are experienced players on the team.
Of course, there are many other checking tools that I use when deciding the chances of a new tech company becoming a success. But the “big four” mentioned above probably cover 90 per cent of the equation. Any investor adopting the rules outlined should, over time, perform much better than the pack.
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