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Why investors struggle to value tech shares

You’ve most likely heard of the term ‘FAANG’ stocks.

This acronym refers to the US tech giants Facebook, Amazon.com, Apple Inc, Netflix, Inc. and Google i.e. Alphabet Inc.

The Australian equivalent might include top ASX tech companies such as REA Group Limited (ASX: REA), SEEK Limited (ASX: SEK) and Xero Limited (ASX: XRO). 

One thing these companies have in common, other than being in the technology sector, is that they are often (if not always) described as being overvalued.

So if these companies are always overvalued, then why is it that they have provided their shareholders with some of the highest returns over the last 10 years?

Its clear that some market commentators might be struggling to value these companies. Here’s why I think that’s the case:

  • Emerging industry. Technology is an emerging and ever evolving industry which makes it difficult for investors to understand compared to the more traditional industries.
  • High growth rates and profit margins. Tech companies typically sell at premium due to their high growth rates and profit margins (if they make a profit at all). This makes them appear expensive when compared to companies in other industries
  • Optionality. Tech companies are typically able to pivot their business in multiple directions. Amazon for example started as an online book store but the same infrastructure it had already built for that purpose was used to set up their cloud computing business (AWS). This optionality comes at a premium.

Foolish takeaway

Don’t make investment decisions based purely on traditional valuation metrics such as PE ratios otherwise you might miss the next ’10 bagger’ stock.

Consider the value of the business to its customers and look ahead at what the business might look like a few years from now.

If you would like an opportunity to discover top shares such as REA Group, Seek and Xero BEFORE their share prices have exploded, then you won’t want to miss this report.

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Kevin Gandiya owns shares of Alphabet (C shares).

You can follow Kevin on Twitter @KevinGandiya.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Apple, Facebook, and Netflix. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool Australia owns shares of Xero. The Motley Fool Australia has recommended Alphabet (A shares), Amazon, Apple, Facebook, Netflix, REA Group Limited, and SEEK Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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