Since the 90’s the global stock market has experienced an explosion, everywhere you turn people are getting rich off tech stocks. A 2021 research report published by Bccresearch.com indicates that the tech sector will continue to experience an annual growth rate (CAGR) of between 20-26%. This article explains why the tech sector grows so fast. Just by understanding the reasons that the tech sector explodes in value every year you can better position an investment to profit.
Here is the short and simple answer:
The tech sector grows faster than every other sector because of the scalability and lack of overhead present in the tech business model. Tech companies can drop a majority of their net profit back into the company propelling further growth. Because tech companies don’t need to pay for a lot of tangible assets or resources at the end of the day. This means companies such as Google, Amazon, Facebook, or Microsoft can scale easily to meet rising consumer demand.
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What Is The Definition Of A Tech Stock
Many people think that in order for a tech stock to be in the tech industry they need to be building software of some kind. That simply is not true.
A tech stock is simply a stock whose company builds or provides services that support the tech industry as a whole. These companies are characterized by 4 criteria.
Tech Stock Definition 1: Scalability of Business Model
First, a tech stock can easily scale. The business model of tech means that a majority of the revenue generation side of the business can scale with consumer demand. Take Facebook for example. As more people use their website they can sell more ads. It scales very easily and little effort or overhead is needed to maintain it.
If the tech company builds a physical product often software will be bundled with it. Tesla for example sells cars with their own software built into it. As more consumers use their cars they inadvertently use the software more as well.
Tech Stock Criteria 2: Low Overhead
Second, a tech company has lower overhead compared to a traditional company. This is because of the nature of the internet. For example, you do not need to buy a physical storefront to sell your goods, you can use a website instead. This is applied to every aspect of the company. As a result the overhead for a tech stock is small in comparison to other companies.
Even Tesla, a car manufacturing company, is considered a tech stock because of the low overhead built into their business model. The software that Tesla built that goes with their cars is going to drive revenue for decades to come. Their insurance plan software alone will drive 30%-40% of their expected future business revenue.
Tech Stock Criteria 3: High Research and Development Expenditure
Third, tech companies spend a lot of money on research and development. This is because the barrier of entry for the industry is low. How tech companies secure their market cap is by building “content moats” around their business model. A content moat is simply a wall of user preferred content that keeps people using their products or services.
Take Google for example. Anybody can build a search engine, the CTRL+F feature for example searches a page for set text. In theory you could build a program that just does this for the entire web. However this would take your computer hundreds of hours to perform one query.
Google on the other hand has invested billions of dollars into building a Google Index that allows this search query to happen in milliseconds. Users don’t use your search engine as they get better service from Google. That is part of Google’s content moat, and in order to secure this they had to invest heavily into Research and Development.
Tech Stock Criteria 4: Products Or Services That Interact With The Internet Of Things (IOT)
Fourth, a tech stock creates products or services that interact with the Internet of Things (IOT). The IOT is becoming an industry term that defines the interconnectivity of all things.
For example you can now activate your coffee machine to start your morning brew based off an alarm you set on your phone. When you get to your mirror to brush your teeth the weather report from the internet will pop up on the mirror. All of these devices are connected, that is the IOT.
Tech companies produce products or services that interact with this IOT. It could be through just a website, or software, or making a car that starts once when your morning coffee is done brewing.
Reason 1: Scalability
There is no other business model out there currently that can scale as easily and efficiently as the tech stock business model.
As a tech company starts to become successful they can easily add or subtract services to fill consumer demand. Because of this there are almost no growing pains that other sectors experience.
Take the energy sector for example. If suddenly an energy company had to double their energy production capacity it would take several months at the earliest to satisfy demand. All that time consumers are left unsatisfied and will have to go elsewhere, taking their money with them.
Now apply the same situation to a company like Amazon. If Amazon tripled their e-commerce sales overnight they could keep up with that massive growth in revenue. They would simply bring on extra services or purchase more server capacity. This could be done in almost an instant and even automated through an algorithm.
Because of this, tech stocks can capture nearly all of the economic growth present in their industry. Their business model grows organically with the growth of consumer demand and services/products can be rapidly rolled out.
This scalability is one of the main reasons that the entire tech industry has exploded over the past 30 years. Companies that got a head start are large household names. These are companies such as Paypal, Amazon, Google, Apple, and Microsoft.
Reason 2: Low Overhead and High EBITDA
Because a tech company does not have to buy a storefront, warehouse, or even office space they save a lot of money. Overtime this saves a ton of money and more importantly removes liability from the company.
Every single physical location a business owns is a liability in some capacity. A normal business would have to worry about fixing the building, hiring people to do so, and making sure the lights stay on. Also depending on the industry there might be certifications that a business would have to satisfy to have a physical location.
All of that takes time and money. Tech companies on the other hand don’t have to incur any major liabilities to start making money. By the time that most tech companies have to buy a building they are already making millions or billions of dollars a year.
Even when tech companies buy physical assets they buy only a fraction of what other companies would have to. This drastically decreases their overhead.
Because they save so much money on overhead tech stocks often have massive EBITDA at the end of the year. EBITDA stands for Earnings Before Taxes Depreciation and Amortization. Basically its just the net profit at the end of the year.
This means that the tech sector as a whole makes a ton of money while only having to pay very little in overhead. This is a recipe for massive growth.
Reason 3: Flexibility To Pivot To Other Services/Products
One of the biggest problems with companies that make millions to billions of dollars per year is that it’s hard to move resources to do something else.
Think of it like trying to move a boat. It’s very easy to change course in a rowboat, likewise changing course in a cruise ship quickly is near impossible. This applies to large companies as well.
Except it doesn’t apply to the tech sector. This is because tech stocks can easily repurpose their resources to develop new products and services in sectors they would like to move into. This is because the overhead is so low in the tech industry in relation to its revenue.
When a company has a low overhead while also making a ton of money they can easily throw money at R&D projects. All major companies in the tech sector do this on a daily basis.
Examples of this are companies such as Facebook/Meta create virtual reality goggles. Tesla created cars, rockets, and entered the insurance business. Apple from 2000-2012 created phones, apps, and computers. Amazon has created a shipping company, the largest cloud hosting platform, all while running their e-commerce business.
As you can see companies in the tech sector can easily pivot their business model due to a large amount of discretionary capital. When a company has millions of dollars sitting around they tend to create lots of products and services.
This is one of the main reasons the tech sector can grow faster than any other sector.
Reason 4: International Presence
Companies in the tech sector have a worldwide sales presence with very little effort.
As long as their product or services can be bought or sold online they can enter into any market in the entire world. This is because they don’t have to deal with international shipping problems or handle complex geopolitical issues.
People in India, Russia, Argentina, and the United States all access Facebook to keep up with their friends. These same people will use Google to search for information online.
This means that the tech sector can reach people in every single part of the world. So long as a person has access to the internet they can be a potential client or point of sale for a company in the tech sector.
The best part about this is the overhead required to reach this massive potential sales audience. A majority of companies in the tech sector have grown from word of mouth as more and more people interact with their products.
This means that the overhead for reaching this massive audience is next to zero. A company just has to put itself out there on the internet and eventually people will interact with their products. So long as the product itself is good then the company in the tech sector will make a sale.
When you compare this to more traditional companies it’s a night and day difference. For example, If you told a used car salesperson that they could sell cars to the entire world through organic word of mouth traffic then instantly that business would be successful.
This is a major reason why the tech sector has grown so fast. In a world of economic globalism companies in the tech sector grow organically.
Reason 5: Can’t Be Considered A Monopoly Even If They Dominate Competition
Software cant be patented. It’s just math and words.
Because of this in theory anybody with a computer can recreate Amazon, Google, Microsoft, or Facebook. By the traditional definition of a monopoly these tech giants don’t stifle competition because they don’t prevent competitors from competing with them.
However many U.S lawmakers have been trying to remedy the dominance the tech giants have over the U.S economy. It’s unclear how these cases will settle in the future. Right now however companies in the tech sector are free to grow to dominate their market.
Even if a company owned 100% of a niche of the tech sector (social media, search, e-commerce) they would not be considered a monopoly because they don’t prevent competition.
Every single year startup tech companies try to take a portion of established companies in the tech sector. They either fail or are bought out by the larger tech companies.
Because tech companies are not considered monopolies currently they can grow exponentially fast. Amazon for example has grown from a garage to a multi billion dollar enterprise in under 30 years. Do they dominate e-commerce, yes, are they considered a monopoly, no.
This is one of the main reasons that the tech sector can grow so exceptionally fast in relation to other sectors.
There you have it; five reasons why the tech sector has exploded over the past 30 years.
In the current environment the tech sector will continue to dominate the world’s economy. However if the U.S passes laws preventing this growth then you could expect this growth to slow down and return to other industry levels.
Here at Chronohistoria I teach people how to generate above average investment returns. I routinely publish articles that go over investment research, methodologies/strategies, and tips/tricks of the trade so that you are better prepared to profit.
Feel free to sign up for the free newsletter to remain up to date on all things investing.
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Until we meet again, I wish you the best of luck in your investing journey.