The world is awash in technology. If you look at a list of the 10 largest stocks in the world by market cap, eight could be considered technology companies. Of the other two, one is a state-owned oil producer, and the other is the investing conglomerate Berkshire Hathaway.

Ever since the dawn of the internet, the technology, computing, and software sectors have gone from a niche part of our society to the dominant backbone of the global economy. For investors, this has created huge winners for longtime shareholders.

Since going public nearly 40 years ago, Microsoft has generated a total return of 675,400% for shareholders who have held since the initial public offering (IPO). That means every $1,000 invested in Microsoft at its IPO would have turned into $6.7 million today. Not bad. Not bad at all.

But how does one find and invest in the right technology stocks? That’s the million-dollar question many investors are asking themselves as they try to find the next Microsoft, Apple, or Amazon for their portfolios. First, we have to start with the basics.

In this article, we are going to discuss:

• What is a Technology Stock?
• Are Technology Stocks Risky to Invest In?
• Comparing a Strong vs. Weak Technology Stock

Let’s dive in.

What is a Technology Stock?

While there isn’t a hard and fast definition, a technology company is generally one that focuses on the development of computing hardware, software, or internet services. It may also focus on innovations in the physical world such as energy innovations, defense/military development, or healthcare devices. Essentially, it is a company that invents new products and sells them.

At first, it might seem easy to identify a technology. There are internet giants like Google, Meta Platforms (Facebook), Amazon, and Microsoft. Add in computing and semiconductor companies like Taiwan Semiconductor, Nvidia, and Apple, and you have many of the largest technology stocks in the world.

But what about a bank such as Bank of America? Its primary business is operating as a consumer and investment bank (not new technologies). Still, it also spends billions of dollars each year on data analytics, its mobile application, and its backend software systems. I could be persuaded these are technology investments.

An even harder question: what about Netflix? The company is essentially just a subscription service for watching videos. However, it invests heavily in its personal suggestions algorithm, improving playback latency and analytics on what customers enjoy watching. I would consider these technology investments.

In the 21st century, almost every company uses modern technology. However, there is a clear distinction between companies that develop new technologies and those that utilize technologies.

A technology company is one that brings new innovations to market, while technology utilizers are companies that simply use these new technologies in their products.

For example, Amazon Web Services (AWS) pioneered cloud computing and essentially invented this new industry. This is a technology company. Netflix uses AWS as its cloud computing partner, which means it utilizes this technology it didn’t invent. I’m sure Netflix has some of its technological innovations, but it outsources its cloud computing to another vendor.

A classic example of technology utilizers is smartphone applications. Apple, Samsung, and others pioneered the modern smartphone universe with technological innovations that brought supercomputers to our pockets. Applications like Uber and Airbnb utilized these new technologies but didn’t invent them. I don’t know if I would consider the core services of Airbnb and Uber to be technological inventions but rather business model innovations.

Other people might define a technology stock differently. But from my perspective, this test is an excellent way to group the proper technology companies driving innovation in our world. Otherwise, you could claim that every stock in the world is a tech company.

Are Technology Stocks Risky to Invest In?

Ok, we have a general understanding of what a technology company is. Now, we must figure out how to invest in them to help build wealth.

The first thing to understand about technology stocks is that they are riskier than the average company.

Why? Because of a concept called technological disruption. Technology companies typically try to invent new technologies to disrupt existing solutions. If there were no market to go after, these companies wouldn’t have a financial incentive to spend millions (sometimes billions) of dollars developing new products.

This can be pretty lucrative if you are the disrupter. Apple stock has soared ever since launching the iPhone, disrupting legacy solutions such as Blackberry and other keyboard-based phones. However, the same can’t be said for Blackberry shareholders. Blackberry stock is currently 98% off its all-time high, showing the risk of disruption from investing in technology stocks.

Disruption makes technology stocks riskier than average. A snack foods company like Hershey or a bank like JP Morgan has much lower disruption risk year in and year out than an electronic equipment maker.

To mitigate disruption risks, investors should spread their bets across many technology stocks as they build their portfolios. You don’t want to put your entire nest egg in one technology stock and watch it fall 90%, ruining your retirement savings.

Technology stocks come with many risks, but they also come with plenty of potential upside. There was no guarantee that Apple would disrupt and eventually dominate the premium smartphone market. But once it did, shareholders were rewarded handsomely. Since the start of 2006, Apple’s stock has posted a total return of 7,680%, trouncing the 476% return for the S&P 500 over the same time frame.

If you start a technology stock such as Apple (back in 2006) as a small position in your portfolio, you can cap the downside from seeing it get disrupted while also participating in the upside if it succeeds and becomes the disrupter itself.

Capitalism can be a dog-eat-dog world for technology stocks. The best way to manage this is to spread your bets to many different companies and allow the winners to emerge for yourself.

But that doesn’t mean you have to invest blindly into every company claiming to be a technology disrupter. There are ways to weed out the pretenders from the true technology innovators when building your portfolio.

Comparing a Strong vs. Weak Technology Stock

Investing in technology companies comes with some unpredictability, so any investor should follow the diversification strategy from the above section. Still, nobody should invest aimlessly when looking at these stocks.

Every technology company talks a big narrative around how they will disrupt the competition. Some follow through and build these products, while others keep pushing the can down the road.

Example: Plug Power

To illustrate this example, let’s look at two extremes on this spectrum. Plug Power is a supposed “green hydrogen” company planning to revolutionize the energy industry with a new clean energy resource. It talks about its hydrogen ecosystem and the huge addressable market within hydrogen energy fuels.

The problem is that it has never actually gotten much traction among customers. Since going public before the dotcom bubble 25 years ago, Plug Power stock is down a whopping 98% and has never generated an operating profit. Despite these woes, the company still consistently tries to hype up its technology, especially during bubbly market periods such as 2020 and 2021, when green energy technology was en vogue.

It should be easy for a rational investor to discard stocks such as Plug Power, which have never shown any traction with their customer bases. This weak technology company does not belong in any investor’s portfolio, no matter how much upside total addressable market (TAM) management touts each quarter.

Example: Amazon

On the other extreme, you have a company like Amazon. Its entire ethos is to invent new businesses from scratch, and they have done quite well at it. For example, it invented the previously mentioned AWS, which has grown to nearly $100 billion in annual revenue and become one of the backbones of the modern internet. This is a robust technology company.

Today, Amazon stock comes with less risk as it has gone from someone trying to disrupt the legacy solutions to dominating many sectors of our economy. But 10 – 15 years ago, it was considered a risky stock to own that generated little (if any) in profits.

Smart technology investors should use these examples to help guide their process for finding new technology stocks to place in their portfolios. You want stocks with a proven track record of getting customer adoption (as opposed to endless false promises from management) spread out over many bets. Then, you want to let your winners run over time.

That is how someone ends up owning Microsoft for 30 – 40 years and turning $1,000 into millions of retirement wealth.