Top 5 things I look for in a technology investment

I believe the technology sector will remain the best opportunity for investors in the next decade. It is already the largest single segment of the US market, eclipsing the financial and industrial sectors. More than anything, technology companies are associated with innovation and invention therefore I use a different methodology to perform due diligence on them. Here are the 5 things I look for in a technology investment.

• Focus on large addressable markets – Investing in technology sector is about financing the creation of much better products to displace existing ones today. If the addressable market is small and costly to scale or if the new product is only slightly better than the existing ones, it is not worth trying. For many high growth technology businesses, one should not ask how much profits they are making today. Instead, one should ask how much value it is creating for its target consumer base, its partners and for the society as a whole. If there is lasting value created and a strong moat to protect the franchise against future competition, the valuation for the business will follow sooner or later.

• Talent & Culture – Since the technology world changes so quickly and product life cycle is relatively short, the value of a technology business lies in the quality of its management and engineering talent. A strong technology team with visionary leadership will be able to attract both talent and committed capital which significantly improve a company’s chances of success in whatever business ideas it pursues. A talent team with an innovative culture will also allow the company to pivot as the company focus changes or when new technologies become available.

• Committed and Aligned Shareholders – Many software and knowledge based products have high upfront investments in R&D and customer acquisition, but low incremental costs once the customers have signed on. A successful technology company needs an investor base that is committed to finance the build-up phase of the business with a focus on long term return, instead of near-term profits.

• Product characteristics – A good technology product should have high gross margin and is used habitually or purchased frequently by the customers. I also seek out the following key elements for success in a technology product:
  • Network Effects – Physical, Protocol, Personal utility (e.g. Whatsapp), Personal (Facebook), Market Network (Angelist), Marketplace (Craigslist), Platform (Windows), Asymptotic Marketplace (Uber), Data (Yelp), Tech Performance (Zoom), Language (e.g. Google, Xerox), Belief (currencies, religion), Bandwagon (e.g. Apple)
  • Lock-in effects from a high training curve or as a de-facto standard
  • Freemium model – Offer a free product to establish a large user base quickly and form network or lock-in effect
  • Link & Leverage – Leverage existing customer base to cross-sell new products

• Opportunities from technology platform shift – Many technology companies succeed by capturing new opportunities made available by a major hardware platform shift such as from TV to PC to Internet to Mobile to Cloud. The best example is how Uber leveraged the emergence of a GPS-enabled mobile phone to create a new mobile, real-time, ride-sharing service. The emergence of a new hardware technology is often a catalyst for novel software applications and innovative business models. Promising upcoming technology platforms include Machine Learning/AI-driven voice interface, AR/VR environment, Autonomous Vehicles & Robotics, Internet of Things and Gene-Editing based personalized medicine.

The Bottom Line

It is not an easy task to evaluate a technology investment. Some investors prefer to stay away from the technology sector and they regard it as overvalued and momentum driven. However, given the pervasiveness of technology in today’s society, this is a significantly self-limiting view that cuts off one of the most dynamic and powerful engines to developed economies’ GDP growth and investment return. A better compromise, then, is to work with a financial adviser that has the experience and track record investing in the sector.