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The Problem with Tech Stocks

Written by Briton Ryle
Posted August 28, 2017

Let me start by saying I don't hate tech stocks. In fact, I love them. I benefit from their products every single day. But I don't always invest in them because, quite frankly, I can't always understand how they will continue to make money. Maybe it's just me. Maybe I have an imagination problem. So let me take you through my thinking...

In 1984, Intel did $1.6 billion in annual revenue. Years later, its spit-adjusted stock price was under $1.10, annual revenue had ballooned to $11.5 billion, and the stock price (again, adjusting for splits) was pushing $4. By the end of the internet bubble, revenue had made yet another massive jump, to over $33 billion. The stock peaked at a little over $66 a share. 

The world was going digital at an amazing pace. And Intel was right on the forefront of that wave, providing the microprocessors that made it all work. 

Yeah, that $66 a share price was a bubble-era price to pay for Intel. It's easy to laugh at the bubble-era investment thesis: as billions of humans get online, Intel will simply sell more and more microprocessors, and revenue will continue to rise. But that was basically true...

Sure, the post-internet bubble recession knocked Intel's revenue down. The trough came in 2002, at $26 billion. Two years later, revenue was hitting new highs. And it kept hitting new highs until 2006, when annual revenue breached $40 billion.

The financial crisis hit Intel, too. By 2009, trailing revenue had fallen below $33 billion. But the world was still going digital, and by the end of 2010, Intel's sales had completely recovered. Revenue was once again hitting new highs, at $43 billion.

Over the last 12 months, Intel has sold $61.71 billion worth of its chips and services. That's 35 years to go from $1.6 to $61.7 billion. Pretty remarkable...

For the last year, Intel's stock price has been stuck between $33 and $38 a share. That's roughly 50% lower than the share price was 17 years ago. Sales have basically doubled, and the stock price has been cut in half. You could have been very right about the future growth of the internet and the potential for Intel to expand. And you could have lost money anyway. 

Of course, this is not exactly a shocking revelation. After all, by now, most people have heard of Moore's Law...

Moore's Law

Right now, Intel is trading with a trailing P/E of 15. That's cheap, right? And the forward P/E is 11! That means you could get a loan right now, buy Intel outright, and pay the loan off in 11 years out of the company's profits. That's a steal! Right? 

Well, how about this...

In 2010, when revenue hit $43 billion, Intel earned $3.18 billion in net profit. Today, with trailing net revenue above $61 billion, the net profit is $2.8 billion. Revenue is up ~50%... and profits are down. 

Is that a company you want to own? Would you really want to have to grow revenues 50% over the next seven years just to earn the same amount of money? This is the problem with tech stocks: they can become victims of their own success. 

Technology companies have to constantly be on the move, expanding into new businesses. Because cycles of innovation tend to happen fast, and if a company misses just one, it's dead in the water. For instance, Cisco tried to expand into set-top boxes and cable modems with its $6.9 billion acquisition of Scientific Atlanta. It didn't work, and Cisco sold the business for $600 million. Cisco's Flip camera was also a failure.

Now, think about all the different businesses Microsoft has tried. It made tablets, it made phones, it made phone operating systems, it makes the Xbox, it bought Skype and LinkedIn, it's got a search engine, it started MSNBC with GE, it's doing cloud software...

Yeah, it took Microsoft a while to really hit with a few of its initiatives. And investors have been rewarded — the stock price has more than doubled over the last few years after languishing around $30 for over a decade.  

Think about how Google has expanded its business — from a search engine to driverless car software. Or Facebook — it is working on solar gliders that can deliver Internet service. Amazon started off just selling books!

The Struggle Is Real 

Innovate or die. That's the deal, and it's not just true with technology companies. So, how do you know which companies are making the right moves and which ones are about to enter stock price purgatory?

Good question, right? And sorry to say it, but I'm not sure there's a tried-and-true method for sorting out the winners and losers. One place to start is to identify existing businesses that are seeing a lot of innovation. I'm going to shift gears here a little and suggest that energy is one of these businesses. 

For decades, demand for electricity and oil has risen steadily. Pump oil and sell it. Build power generation and sell it. Simple enough that ExxonMobil was the biggest company in the world for a while. And utilities were called "widow and orphan" stocks because they were so reliable. 

But that's changing... fast.

In just the last five years, the cost to pump shale and other "tight" oil has been cut in half. Saudi Arabia has lost control of the oil market. Oil demand is rising a little, but consider that since 2007, the average new car has gotten 25% more efficient. You don't even have to look at electric cars — innovations to the good ol' internal combustion engine are pressuring demand. 

And the situation is even starker in the electricity market. Electricity demand peaked 10 years ago in 2007. Today, the average U.S. household uses 9% less electricity than it did a decade ago. 

Both the Department of Energy and the EIA say energy consumption in the U.S. isn't going to grow meaningfully over the next decade — or more. That is remarkable. 

You can be sure there will be winners and losers as this trend of energy efficiency plays out. For instance, oil majors like Exxon have diversified into natural gas to offset the weak oil market. But if electricity demand isn't growing, will natural gas be a growing business? It's hard to imagine that it will.

Until next time,

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Briton Ryle

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An 18-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.

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