I don't understand investing in tech companies

Stocks
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I answered the Inderes survey on the homepage about tech companies, and I had to dig up some key figures for the companies to answer. Almost all the companies in the survey were either unprofitable or had listed on the stock exchange at peak valuations. Among them were a couple of older firms: F-Secure was the only one that had remained profitable in the long term, while Basware showed that its business was not profitable.

Tech companies seem to be in some kind of bubble. When Admicom makes a profit of 3.2 million euros, the market values this profit at 190 million. What about unprofitable firms? If unprofitability is kindly interpreted as an investment in growth, what kind of investment is it in this industry? Is a tech company’s investment aimed at achieving a monopoly, or does the company just have to keep up with constantly changing technology? My computer’s software is constantly updating, and I’ve never understood what significance some Microsoft update package has in my life. Then I have to search online when a previously working feature no longer works.

Technology is not the future; it’s already here all the time. Online stores and payment systems are no longer a new thing. For every company, one must ask what value the firm creates for its stakeholders. I don’t care about your goal of creating a platform that competes with Steam or YouTube; as a consumer, I want compatible standards, low search costs, and effortlessness. Investors, upon hearing the word ‘platform,’ add a zero to the acceptable valuation.

Is your firm the best available option? If not, continue developing, hope for the best, and for investors’ patience. If you are the best option, how much better are you than your competitors? This creates the margin. Global competition is ruthless, and luck also plays a role. Can you build a brand with any generic option? In ten years, the world will look completely different anyway.

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I have Talenom (it generates a strong cash flow, although the share price has risen by 200% in a little over a year, but my first investment at 11 euros has already yielded 5% in dividends alone. A couple of years of growth, and the most recent purchases at around 31-32.1 euros are also generating a decent cash flow).
You might say it’s an accounting firm, but I actually see it as a software company, which in principle could probably become a separate software company in the long run…

Qt Group, things have progressed well, the industry is a bit special, the company already has 12 million in license revenues, even though it has been said that these license revenues will only really start flowing in 2020. I assume that if things continue to progress, there will probably be a dividend stream in a couple of years, but the original investments made at 6.6 and 6 euros have risen by about 100% at the same time (maybe I could sell sometime if I want that cash flow?!).

F-Secure, if one looks at historical profitability and the current focus on the enterprise sector, which seems to be progressing in principle, and considers the increase in data volume, etc., I could imagine that when it is no longer seen as profitable to grow so fast, that profitability will indeed come through. That is, at the current price, if one has acquired one’s shares as I have.

Edit: I also have Efecte (the latest quarter is already more promising.. we’ll follow that).

I do like it better if money comes from bits rather than furniture or steel; you don’t seem to get it as well from those.

In a way, the Talenom’s approximately 200% return and Qt’s approximately 100% return already cover Efecte’s approximately 10% loss quite nicely?

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Perhaps the outlook also depends on the purchase price?

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Is Revenio a software company? It’s nice that they’re starting to sell that home data from those HOME devices, so they get free profit :slight_smile:

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Admicom (I owned it and made the worst 30% profit of my life), you could still get it for about 10-11 euros a while ago. Now the price is 40 euros.

Would 11 euros feel cheap, even with current numbers and forecasts?

You could have also gotten Efecte for well under 4 euros in December.

P.S. I haven’t looked at the poll, when was it, and I apologize if the expression is provocative now. I’m hungry.

I just filled it out. For example, Basware, does it have good earnings growth prospects? The earnings are currently in the red, and the new CEO is letting people go and promised to make the company cash flow positive by the end of 2020? So earnings are growing, but probably not absolutely good?

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I understand investing in tech companies as a good foundation because, in practice, one company can well dominate its entire operating environment in the future. This, in turn, practically means a very permanent moat until future technology does the same task faster or better than the existing solution. On the other hand, in many cases, a dominant company gets its hands on this new technology first due to its size. Of course, most of them will not become success stories like Salesforce or Intuit, which completely dominate their own industry.

Additionally, due to the extremely good scalability of tech companies, investors are willing to accept ugly-looking losses for a certain period of time.

There are no full-fledged tech companies in my own portfolio, mainly because I don’t feel I necessarily understand technology and technological development well enough, and because the competition between tech companies is extremely fierce. Perhaps in the future.

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Talenom wasn’t a software company in the survey :smiley: ? Apparently it’s an accounting firm?

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A productive investment focuses on future cash flow-based returns for the investor. The rest is speculation, but I’m not saying one can’t get rich through speculation. I examine my investments on a fundamental basis, but I consistently find that tech companies categorically appear to be poor investments. While the value creation of consumer goods companies is easy to understand – how German luxury car manufacturers use money to build a brand – it’s harder to grasp the value of a programming language or a specialized application.

There’s a strong effort to explain that there is value in sniffing out what consumers do. It produces data, intangible assets, which are more valuable than gold. Those who ask about capital are considered stuck in the past. Investors should accept unsecured credit in a company’s story. There’s nothing wrong with risky investments, of course, if one has nerves of steel. What if other investors lose faith? I am absolutely sure that Nokian Tyres will continue to sell tires no matter what the stock price is, but a tech company might struggle when management bonuses paid out in stock offerings dilute the shares of all owners even more. This is also the secret to the growth of the mighty Amazon.

It’s possible that I just don’t understand how tech companies make a profit. I wouldn’t have predicted Outokumpu’s or Finnair’s earnings per share to exceed one euro either. I created this thread to learn more about tech from those who know more about it.

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"I believe it’s important to thoroughly research targets and continuously monitor progress. I’ve personally increased my stakes when things have moved in the right direction.

However, I wouldn’t invest in just anything. I think it’s essential to look at least 2-3 years ahead with these investments.

But in my opinion, even my favorite, Talenom’s (P/E ratio), cannot be on the same level as Nokian Tyres or Outokumpu.

P.S. I also own Nokian Tyres, and I think it’s a good company. Of course, profitability will be challenging for some time."

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Excellent start. I don’t always understand correctly either.
I tried hard to understand sometimes 4-5 years ago, when the Kauppalehti discussion forum was raving about a company called SSH and its mind-blowing future.

I looked at the numbers. The company churns out losses year after year or struggles with zero profitability. Yet the share price was skyrocketing and the multiples were through the roof.
I didn’t get it. Or I did get it: hype. Investors saw the potential for a big leap here, but not the threat that the same old trend would continue.

I wrote on the forum that the company was at an incomprehensible price given its ability to make losses and that I would rather invest my funds in companies whose future earnings generation and market price of the share had some understandable connection.

I received such a torrent of abuse from investors caught up in the hype that it was beyond belief. The main content of the messages was that I was the one who didn’t understand. And that SSH would make everyone “millionaires” in a few years. The stock would rocket to twenty and more in an instant.
Right, of course.

At that time, SSH’s share cost well over 4 euros on the stock exchange.
Today, it seems to cost just over 1 euro.

I’d like to go and ask that if I was the one who didn’t understand,
then what does that make all those who “understood”?

I have an answer to that too.
It’s “poorer”.

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Good opening. First, I must state that if you feel that the pricing of tech companies is wrong and that they have an unreasonably massive hype premium, then you will increase your probability of beating the market in the long run by refraining from investing in tech companies. Successful contrarians make the biggest excess returns (and unsuccessful ones pay heavily for their stubbornness).

Here are a few special characteristics of tech companies compared to more traditional companies, using the VeHi method:

  1. Low marginal costs
  2. Unlimited or nearly unlimited capacity to distribute their products to the market
  3. Especially for SaaS companies: service-based billing (Netflix sells the same account monthly)
  4. In many industries, a “Winner Takes it All” situation

For example, Admicom, mentioned by Juip at the beginning, is a good example of each of these. I do not own Admicom.

  • The costs of a new customer are minimal: web-based ERP can be easily delivered to companies.
  • Practically every potential customer can be served, as no product is manufactured in a factory whose capacity would run out. If an internet-based product starts to falter, you just go buy a bit more capacity from the store.
  • Admicom makes agreements several years in advance, giving excellent visibility. This significantly lowers the company’s risk level.
  • Admicom has wisely chosen its market niche, where it is constantly becoming more dominant. The company is becoming the sole ruler of its chosen industries.

In Admicom’s case, it’s easy to see why tech companies can be paid a lot, as the company can, in the best-case scenario, grow extremely profitably many times over without additional investments. On the other hand, the company’s riskiness is limited based on its existing profitability. For these reasons, companies are paid a lot.

As for Pika-Sissi’s example of SSH, I must agree in the sense that tech companies indeed carry huge risks. Especially if a company is making a loss, the expected return of a probable scenario must be extremely positive for it to be rational to invest in. Tech companies are rarely all-in cases. Many have gotten their fingers burned, and it’s always instructive to read these investor stories from forums. So always remember moderation and the golden rule of diversification.

Here’s a bit of a stream of consciousness and justifications for my own tech company investments. You can check out the composition of my own portfolio on Shareville.

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I would also answer that survey. Of the companies in this survey, only Admicom & Efecte were the most familiar to me.

I understand Juip’s point regarding these tech companies. I also invest based on fundamentals, and each company in the survey should be analyzed on a case-by-case basis. I wanted to state my own position regarding Efecte’s unprofitability, and the company’s valuation is not unreasonable when viewed with the revenue multiplier (EV/S ≈1.6). I consider Efecte a relatively safe long-term investment in the end, because the company likely has very low customer churn, revenues are recurring (as is common with SaaS companies), and its products already have a proven track record in terms of competitiveness, e.g., a strong foothold already in Finland, positive satisfaction surveys, and winning major accounts in Germany, etc. Efecte could practically also make a profit currently without large sales investments. However, revenue growth has been a little too modest. But that’s it. Overall, when one glances at the companies in the survey, there is some commonality among them, for example, precisely this unprofitability and/or having just listed on the stock exchange. The SSH mentioned by Pika-Sissi could be precisely one of those cases where a nice tech premium is baked into the stock price. I haven’t delved into the company, nor have I really thought about it right now.

This thread could be one where, for example, Finnish software companies/tech companies are highlighted (and shot down accordingly :D) so it might be easier to get a handle on different companies at different times :thinking: many tech companies are still semi-unknown to me as well.

P.S. Niklas, you got a new follower on Shareville :+1:

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SSH’s valuation at the time was based on patents. Ultimately, however, the patents were invalidated in court. If they had been able to cash in on the patents, there would not have been an overvaluation at the time. The case was not clear-cut, so the patents had to be given a price based on assumptions. Now that the patents cannot be monetized, the price has continuously fallen towards the value of the business itself. It is not reasonable to compare SSH’s previous valuation to its current one.

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For Efecte, I felt that the latest quarter definitely showed a strong light at the end of the tunnel, but a little more reassurance is still needed. The new German customer who also acts as a reseller seemed very nice!

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More than a third of my portfolio is in tech, but apparently, this thread mainly discusses software product companies, which I currently have very few of. I haven’t intentionally avoided them; I’ve just found what I consider better investment opportunities in the technology sector (mainly on US exchanges).

F-Secure is currently the only software product company I’ve deemed worthy of a place in my portfolio from the Helsinki Stock Exchange. I believe in the sector’s growth far into the future because soon it will be difficult to find a product that doesn’t have at least one computer embedded in it (with software and security issues within that software). F-Secure is a sufficiently large player in its field, has always had competitive products, and generally a good long track record. It is also sufficiently liquid (this condition alone can rule out a large number of Helsinki’s small tech companies).

At the core of tech firms is product development, which is a continuous race against others. Similarly, sales and marketing are ongoing activities. I don’t understand these narratives where either of these is treated as some temporary investment. If you slow down, others will pass you by.

Even if you’re first to market, it doesn’t necessarily mean anything. It doesn’t even necessarily mean anything that you dominate the market in the early stages. For example, Netscape made the first really good web browser. Netscape achieved over 90% market share in the mid-90s. Its market share in 2006 was 1%, as Microsoft and many others easily overtook it.

Usually, people only remember the winners. However, for every winner, there are long rows of failures in the graveyard of tech companies.

Having seen quite a few first releases of products, I can say that almost always the first release requires significant patching later. The more parallel releases/products to maintain, the larger the proportion of staff goes into maintaining the old and is away from developing the new. Then, to top it all off, you can add customers who demand customization.

Tech companies can easily become locked into a certain platform/technology, as happened with Nokia’s mobile phone division and Symbian. Apple didn’t invent the smartphone; they studied existing products on the market and made one that was many times better. They had no legacy burden and had done their homework exceptionally well (their first release is famously not rubbish - the exception proves the rule).

Especially large companies have the option that Apple used with smartphones and Microsoft with web browsers. They let smaller companies push a technology, and then either buy them out, litigate them out, or develop their own much better product for the same market.

The problem for small companies is that they have very small product development (and sales/marketing) organizations. A large company can put 10-100 times the same amount of skilled people to work and achieve the same level quite quickly. Similarly, a large company can easily find a bunch of patents with which to sideline a smaller player (Motorola attacked Nokia as soon as Nokia’s market share in mobile phones became “significant”). With small companies, litigation doesn’t even need to be won - it’s enough that it drains years of money and resources (which a large firm has, but a small one might not).

In my opinion, a tech company can achieve a sustainable moat only through large size. In such cases, they usually have a good brand, a large patent portfolio, a large product development department, a large sales/marketing department, and several successful products. That is, replicating something similar becomes difficult.

I don’t believe that all the new-era companies currently in the lead will still be with us as independent entities in 20 years. The same thing happened to most of those who were in the lead in 1999-2002 and survived the bubble (e.g., Yahoo is no longer an independent entity and, before ending up under Verizon’s ownership, began to be just a shadow of the power Yahoo was in 2000).

In addition, in the semiconductor technology sector, for example, the moat is deepened by production technical expertise and the fact that each generation’s production line costs more than its predecessor. Currently, we are at a level where even giant companies may not embark on building a factory alone.

Yes, good tech companies can be found, but I, for one, no longer believe in stories.
There must be evidence, size, and liquidity.

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If such a “revenue without additional investments” story works, it truly revolutionizes business. The effectiveness of this story can be examined company-by-company using the Asset Turnover ratio. This is obtained by dividing the fiscal year’s revenue by the average of the total assets at the beginning and end of the fiscal year. If the hypothesis holds true, the ratio should steadily increase over time. For many traditional companies, too, the ratio fluctuates with business cycles and demand. However, revenue is much less volatile than the lower lines of the income statement, and it is not easy to manipulate. I added the figures for a few companies mentioned in the thread to a spreadsheet. I am not claiming that these companies have guided for revenue growth without additional investments. The Asset Turnover ratio also says nothing about profitability.

asset%20turnover
asset%20turnover549×137 1.59 KB

If revenue does not grow automatically, we are among ordinary mortals. Growth requires additional investments, just like in all other industries. Additional investments, in turn, depend on profitable business operations or investors’ loose purse strings.

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At first, I was a bit lost as to what the idea of this thread was, but this has some pretty powerful and thought-provoking text…

When investing in a tech company, there are usually a few things that make it difficult to analyze the company or find a future winner; for example, almost always fierce competition because the product is likely desired, difficulty in determining the correct valuation (and easily overpaying), and overall difficulty in envisioning the future, who wins and who loses the game, depending on the company, of course.

That’s why it’s nice to invest in something like Harvia. It’s unlikely that any home appliance giant, such as LG or Electrolux, would be interested in a slow-growing sauna & heater market worth a couple of three billion. :face_with_monocle:

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Efecte’s balance sheet shows that investors have provided the company with 10.6 million euros in capital. Of this invested capital, only 3.4 million euros remain due to continuous losses. Efecte is not a safe investment; it’s a belief that the company will turn profitable before facing financial difficulties and bankruptcy. At the same time, investors are paying 27.5 million euros for the company. Traditional companies like Stockmann and HKScan also generate losses, but investors are only willing to buy their shares at a significant discount to their balance sheet value. Even cash-flow positive real estate investment companies, which operate on the brink of profitability, are valued at a discount to their balance sheet.

There’s no rhyme or reason to the valuations of tech companies. What kind of return on the 3.4 million euros of Efecte’s capital would it take to justify a valuation of 27.5 million? The mighty Google, where the world’s most brilliant engineers work, has an equity return of 18.6%.

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Indeed. Chapter 3 of Masse’s Investment School begins: “There are fundamentals that are very difficult to manipulate, and then there’s the famous sentiment that, in some companies, at least temporarily dictates stock prices.” If you stick to the fundamentals, you can’t get poorer, but if you go with the sentiment, there’s a risk that your money will disappear.

Of course, one can try to ride the hype-sentiment upswing of a tech company, outsmarting dumber colleagues and selling in time, but the risk for oneself is then quite high.

Masse, FA, portfolio with a very strong fundamental basis (excl. Lehto) :toolbox::toolbox::toolbox:

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Efecte has indeed suffered over 7 million in losses during its history. The loss for the 2018 fiscal year was over -2.4 million euros, which was quite a lot. Last year doesn’t give much cause for celebration.

However, Efecte has been able to grow steadily, about 17% per year, using retained earnings before its listing at the end of 2017. SaaS growth has been strong from the beginning, but a sharp decline in one-time licenses has kept overall revenue moderate. At the moment, I am examining the company’s current profitability and revenue growth, rather than focusing on how much the company lost in 2013.

The company raised 5.1 million euros from the offering, and 2.4 million euros were already burned in 2018. In the last quarter, operating profit was -0.5 million euros. If we follow Petri’s forecast, for example, this year’s EPS will be -0.22, next year -0.15, after which about half a million of the offering funds would be left, and by 2021, after this strategy period, the company should already be making a profit.

So, the company doesn’t have too much money. However, in Q1, the company had liquid assets of 5.7 million euros, and in the comparative period, 6 million euros. It has never needed to take on debt. Customers have started paying well for SaaS services, so I would assume that the worst is already behind us. I hope (and believe) that the company will manage with these funds. The company will likely maintain the same growth pace in the future, but at some point, this growth should become self-sustaining, and profitability will rise accordingly.

I was also concerned at some point about the company’s cash position and the magnitude of growth investments relative to revenue growth and profit. The company itself probably was too. Currently, I am a little more relieved. Although I said I consider this a relatively safe investment for the long term, the company still has something to prove. Funding is what still worries me the most, then the competitiveness of the company’s products is a concern. I do believe the company has found a good niche (e.g., the large player ServiceNow is not interested in smaller companies, as I understand it), has strong growth prospects, and a competitive product. As long as SaaS growth stays above 20% and profit rises at least close to the forecast, there should be no problem. I just hope the company wins some big deals.

But now, back to watching the game —>

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