The Press, February 2012
Technology stocks are the sirens of the investing world. Like the seductresses of Greek mythology, tech lures unsuspecting investors with enchanting stories of fame and riches, only to wreck them on the rocks of unrealised potential.
While it’s not quite ostrich farming or one of those dodgy finance companies, investing in technology companies can be fraught.
Famous US investor Warren Buffet has famously avoided technology investment, true to his rule of not investing in things he doesn’t understand. And although he has taken stakes in the likes of IBM and Intel in recent times, Buffett has avoided losing money during the various tech bubbles.
The secret to successful technology investment is not actually about understanding the innovation.
These inventions can be very exciting, and their inventors are typically brilliant, passionate people. Ensuring your enthusiasm for a piece of technology is matched by your excitement about the quantified and proven market opportunity is the key to successful tech investing.
Investors and their advisers are thorough in terms of evaluating fundamentals like quality of management, intellectual property protection, company structure, capital structure and so on, but due diligence on market opportunity often lacks depth and credibility.
The ‘exactly who are we going to sell it to and why would they buy it’ is the one aspect often overlooked. It doesn’t matter how sophisticated your financial projections, ownership model or licensing structure, the only thing that counts at the end of the day is whether you can find enough people to buy the product, for significantly more than it costs to build.
Doing due diligence on the market side of tech investment has three aspects.
First is whether the company has clear understanding of what their product does or could do for customers. While this sounds ridiculously basic, it is actually absolutely fundamental and too often overlooked.
Understandably technologists focus their energies on the invention itself. The latest carbon fibre materials used, the new spring loaded mechanism, the smart control software, the cool iPhone app.
Not unimportant for investors is understanding at least in broad terms what the product is, but what is also critical is being clear of what it does for the potential customer.
What is the technology’s purpose, its contribution to the life or the business operation of the customer? Does the product make things easier, faster, or cheaper for consumers, or if it's for a business, does the product help gain more customers, improve margins, or drive efficiency?
It needs to be helping to solve a very big problem for a good number of people to be an attractive investment proposition. What evidence is there that the problem actually exists?
Focus is the second essential indicator of a tech company’s investment readiness. Companies with a strong sense of market focus are the most likely to have high growth rates, according to the 2011 Market Measures study of hi-tech sales and marketing, produced by Concentrate and PricewaterhouseCoopers.
Companies that make a good investment are ones that have worked through a market selection process and have identified the highest priority markets. Markets that have a lot of potential and where the company is well placed to succeed.
The last thing you want to hear in an investment pitch, is ‘if we can only get 5% of this market we will more than meet our projections.’ As technology marketing guru Geoffrey Moore says, "When you hear that sort of stuff, exit gracefully, holding onto your wallet".
Target markets may be very large or very niche, but they should always be very specific. Particularly if the tech company is targeting businesses then there is no excuse for not having a list of all the companies in their market.
Which takes us to the third key of attractive technology investments - with clarity around target market comes clarity around the way the technology is going to be marketed and sold.
For example, if you don't know how to enter the Australian market, then you probably just don't know enough about the market yet. Who the players are in the market, what customers are currently using, how potential customers find out about new solutions and where they go to source them, satisfaction with current solutions, key business issues for companies in the market.
Companies with a specific idea of who their customers are, and a clear view of the value they are offering them, are most likely to have a clear strategy and therefore the greatest confidence in achieving their projections.
It is not asking these questions that gets people in trouble with tech investing. During the dotcom bubble, people got excited and enthusiastic about technology. The world was changing, new models of business were emerging, but it was still all about understanding where the value for the customer was and how that could be turned into profit.
Ignore that fundamental truth at your peril, no matter how alluring the ‘music and singing’ of the tech stock sirens.