How to Invest in Tech With the End Goal in Mind
Editor's note: If you're building wealth for the long term, you're not trading for a quick buck... And our colleague Dave Lashmet has a proven track record of finding businesses that invest in the future. In today's Weekend Edition, we're taking a break from our usual fare to share this piece, which we last published in DailyWealth in October 2023. In it, Dave reveals how to spot investments that can skyrocket into future winners.
Today, I want to introduce you to the concept of "proactive investing."
Don't bother Googling it – it's not a long-standing school of investing. I made it up. But I believe it's a useful mindset for all new technology investors...
You see, there's a clear difference between trading and investing. Trading means buying a trend – or better yet, getting ahead of a trend. It's tied to money flow in a broader market, a sector, a fund, or a stock.
But even high-flying momentum stocks can fall back to earth. Of course, with the right plan and execution, you can be a successful trader... You just have to understand how it's different from long-term investing. And you need to know which of the two you're doing.
So, how do you invest for the future? Rather than worry about what other investors are up to, I try to consider what the equity is up to. This is especially important in tech investing.
Here's an example to show you what I mean...
In the summer of 2020, my family found a 5-acre plot of trees in Washington state. It's 100 feet above sea level and only five minutes from the fast ferry to Seattle. It's flat land at the top of a hill, with no creek or swamp in sight. It's the perfect place to build a country home.
We set out to put in a road... then a writer's cabin, a well, and a septic field. We planned to eventually turn the cabin into a small home. And we estimated the whole project would take about four years and $400,000.
Of course, when you begin a project like this, you can't know the exact resale value four years from now... or the precise day you'll finish... or even how much it'll actually cost. But every step brings you closer to a tangible goal. One day, there's a foundation. The next, there's a roof.
In our case, our market research suggested that, eventually, this would be an elite residence... And we'd be able to sell it for a pretty penny to some tech executive who only needed to go into Seattle once a week.
We wouldn't even have to finish the building project to see a return on our investment. There'd be added value at every stopping point in the process. Even with the house unfinished, each of the other fixed assets – the land, road, cabin, well house, and septic field – would be valuable and could help someone else finish the job we'd started.
Similarly, when you're a proactive investor, you have to see the end goal and all the steps it takes to get there. That's because the process itself has value – even if the wisdom of many investment advisers is that "the future is risky, so just live in the moment."
When you think of evaluating how companies use their cash to invest in future growth, maybe your first thought is to look at research and development (R&D) costs. The problem is, U.S. accounting rules treat R&D costs as current losses.
A better approach might be to follow Sweden's example... and treat R&D costs like investments.
For the best tech companies, putting $100,000 a year into R&D for four years is a lot like my real estate investment... It's building something that will unlock value in the years to come.
A company might use this cash to invest in unique technologies that its peers can't match. Or it could make itself independent by developing its own manufacturing capacity, while its rivals are forced to pay higher and higher prices to compete with each other in the manufacturing chain.
Tech investors would do well to understand Sweden's approach to R&D. The value of a company isn't based on last quarter's sales – because those sales can't tell you much about what the business will look like next year... or four years from now.
The Number You Should Be Looking At
Instead, look at what a company is building right now. From there, you can weigh future demand, do a competitive analysis, then predict the value of a forthcoming product and how that adds to cash flow.
We like to look at free cash flow ("FCF") because it's the number that doesn't lie...
FCF is what a company has left over for dividends and buybacks after everything else is paid. That's how the company pays you, the firm's part-owner.
Note, all of this is unaffected by the trends in the market. Rather, it's about what the asset can be worth to you – measured against both what it cost to acquire and the cost of holding on to it.
We can use this "proactive investing" logic with companies of any size... whether we're looking at small firms or larger, more established technology companies with a long history of profits, as well as proven marketing skills, demand, and an ability to hold off competitors.
In short, if you want to invest in tech, look for companies that are building things of value in the present... for a lasting competitive advantage. That's the best way to successfully invest for the future.
Good investing,
Dave Lashmet
Editor's note: Dave is the man behind our firm's most profitable research ever. He has outperformed the world's top 10 fund managers for five years and even doubled Warren Buffett's annual return...
And on Thursday, June 4, he's going public with a huge revelation that everyone in America needs to hear. It involves a revolutionary new technology funded by the Pentagon that could potentially make millions for investors who are brave enough to take a position now. But you have just one chance to get the full story before it's too late.