Technology stocks have been a hot topic among investors for some time. More recently and throughout 2020, the rise of big tech as fueled by the COVID-19 pandemic has led to even more interest in the sector.
How could you ignore gains like what we have seen from Apple (AAPL), Amazon.com (AMZN), and Alphabet (GOOG), who saw gains in 2020 of nearly 80%, 70%, and 30%, respectively? Considering the average return in the stock market is around 10% annually, these returns are mind-blowing.
But what exactly are tech stocks? And should you invest in them?
What Are Tech Stocks?
Tech stocks, a shortened term for technology stocks, represent companies within the technology sector. These companies lead the charge in terms of innovation, looking for answers to some of the biggest challenges consumers face today. For example:
- Autonomous Vehicles. One of the hottest new trends in technology, several companies are racing to produce safe autonomous, or driverless, vehicles. The idea is that by automating the driving process, human error is taken out of the equation, leading to fewer traffic-related injuries and reducing the financial burden car accidents have on consumers and the economy as a whole.
- Medical Innovation. Several biotechnology companies are developing new therapeutic options for ailments that were once considered untreatable. Just 20 years ago, AIDS was considered a death sentence. Thanks to cutting edge technology and medical innovation, it is a manageable condition today.
- Communication. Due to the coronavirus pandemic, there has been a rise in video conference technology that allows patients to communicate with doctors, family members to keep in touch, and co-workers to discuss their next moves. Several companies offer technology that facilitates video conferencing.
That’s just scratching the surface of all the tech sector has to offer.
No matter what you’re doing, from driving to watching television or even walking down the street, technology has likely made it a better experience in one way or another. Investing in tech stocks gives investors the ability to gain financially from this improvement as technological innovation continues.
Pro tip: You can earn a free share of stock (up to $200 value) when you open a new trading account from Robinhood. With Robinhood, you can customize your portfolio with stocks and ETFs, plus you can invest in fractional shares.
Subcategories That Make up the Tech Sector
The tech sector is vast and made up of several subcategories, including:
1. Information Technology and Cloud Computing
By definition, information technology is the process of using computers to relay, store, or manipulate data. Companies in this space include cloud computing companies that give consumers, corporations, and government agencies the ability to store data in and retrieve data from “the cloud,” which is made up of a large group of highly secured servers.
Some of the most popular companies in the information technology and cloud computing subsector of the tech sector include:
- Amazon.com (AMZN). With Amazon Web Services, also known as AWS, Amazon.com is by far the leader in the United States cloud computing sector. According to Statista, the company controls about 33% of the cloud computing market.
- Microsoft (MSFT). Microsoft is another massive player in the cloud computing space, thanks to its Microsoft Azure product. According to Kinsta, Microsoft controls about 17% of the cloud computing market.
2. Artificial Intelligence
Artificial intelligence (AI) has become the next big thing in the world of technology. Technological innovation has led to computers that can learn, giving them the ability to do everything from having conversations with consumers to predicting short-term and long-term market trends.
- Amazon.com (AMZN). Amazon.com is a leader in various spaces, and thanks to its Alexa product, it’s a clear leader in the artificial intelligence space. People use Alexa to do everything from play music to close blinds and turn on lights in their homes. With Alexa, Amazon.com has also become a leader in the smart home space.
- Apple (AAPL). Apple is also a major player in artificial intelligence and is one of the pioneers in the space with its virtual assistant Siri. Today, Siri is found on every iPhone, iPad, and Apple computer on the market and has been an integral part of the company’s control of the smartphone space.
- Alphabet (GOOG). Google, the most significant subsidiary of Alphabet, has long believed in the power of artificial intelligence, which has been used in everything from the search results it provides to the advertising that drives its revenue. The company has also been part of several experiments surrounding artificial intelligence for real-world use and has become a major player in the smart home market with Google Nest, the largest competitor to Amazon.com’s Alexa.
Another major area of the tech sector is e-commerce. If it weren’t for the technological innovation that drove the development of content management systems, digital payment processing, and the servers that tie it all together, you would still have to drive to the store and hand over cash to buy everything you wanted.
These days, just about every product is available online. Moreover, the COVID-19 pandemic led to mass adoption of online shopping, even among those who wouldn’t consider the option otherwise. Some of the biggest players in the e-commerce space include:
- Amazon.com. Amazon.com is a leader in yet another area of tech. In fact, it was the e-commerce sector that led to the birth of Amazon.com in the first place. As a pioneer in the space, the company is the largest e-commerce company on the market today.
- Walmart. Walmart isn’t only a leader in the brick-and-mortar retail industry. The company quickly saw the threat that Amazon.com would become and built Walmart.com early on in order to maintain its leadership of the retail industry. Although the company does lag behind Amazon.com in the e-commerce subsector of tech, it is still a powerhouse in the online retail space.
- eBay (EBAY). Although eBay isn’t nearly as large as Amazon or Walmart, it is a formidable player in the e-commerce space. Starting as an online auction site, the company now offers both auctions and the ability to purchase items in real time at discounted prices.
When you think of tech companies, it’s not likely that your mind will go to medicine. However, some of the most impressive tech stocks on Wall Street use technology as a way to address some of the world’s most pressing medical conditions. These companies are known as biotechnology or biotech companies. Some of the best-known companies in the biotech space include:
- Novo Nordisk (NVO). Novo Nordisk is one of the largest biotech companies in the world. It is credited with developing the technology that led to drugs like Levemir, NovoLog, Novolin R, NovoSeven, NovoEight, and Victoza. The company’s primary focus is on the treatment of diabetes and hemophilia as well as growth hormones.
- Regeneron Pharmaceuticals (REGN). Regeneron Pharmaceuticals develops technologies for the treatment of eye diseases, cancer, cardiovascular diseases, allergic and inflammatory issues, and infectious diseases.
- Alexion Pharmaceuticals (ALXN). Alexion Pharmaceuticals develops technologies for the treatment of cardiovascular and autoimmune diseases.
Cybersecurity is an important area of technology. Cybersecurity companies are charged with keeping your information safe and ensuring that you’re not the next victim of identity theft or a cyberattack. Some of the largest companies in the space include:
- NortonLifeLock Inc (NLOK). NortonLifeLock was one of the pioneers that created the cybersecurity industry. The company provides consumers and businesses with tools to keep their data safe from online fraudsters.
- Cloudflare Inc (NET). Cloudflare is a business-to-business cybersecurity company, offering an option for companies to protect themselves from hackers. The company’s claim to fame is its firewall that not only increases the speed of websites, but also stops threats in their tracks.
- Fortinet (FTNT). Fortinet is an enterprise security company. The company provides products like security-driven networking, cloud security, and AI-driven security.
Without semiconductors, the massive servers that host the world’s largest websites and the computers and mobile devices used to access them simply wouldn’t exist. In many ways, semiconductors are the power that keeps the information technology, cloud computing, and even blockchain industries alive. Some of the major players in the semiconductor industry include:
- Advanced Micro Devices (AMD). Advanced Micro Devices is one of three key players in the semiconductor industry. The company’s claim to fame is Ryzen, one of the world’s fastest computer graphics processors, used in gaming, blockchain, and cloud computing around the world.
- NVIDIA (NVDA). NVIDIA is Advanced Micro Devices’ closest competitor. The company is the inventor of the GPU and the leader in the provision of semiconductors for the cloud computing and artificial intelligence space.
- Intel (INTC). Intel is a household name in computers and has been creating semiconductors for decades. Although the company seems to be struggling to keep up with the technology coming out of AMD and NVIDIA as of late, it is still a clear leader in the semiconductor space.
7. Social Media
In the days of MySpace, social media quickly became a way to meet new people and connect with old friends. Today, MySpace is more like “MyWhat?” and the social media industry has several key leaders. These include:
- Facebook (FB). Facebook is the clear leader in the social media space. Once launched, the company took the social media industry by storm, largely making MySpace obsolete. Today, Facebook boasts 2.7 billion active users and is one of the largest online advertising agencies in the world, advertising exclusively to its social media audience.
- Twitter (TWTR). Twitter is another major player in the social media industry. Although the company isn’t quite as large as Facebook, it has become the leading social network for those interested in news.
Pros and Cons of Investing in Tech Stocks
Investing in tech stocks can be an exciting concept. Not only is it enjoyable to explore new technologies during your research into compelling investment opportunities, but the sector is known for generating significant gains when the right moves are made.
However, it’s not all sunshine and rainbows. Like any other sector, the technology sector has its own skeletons in the closet. For example, heavy volatility and a cyclical nature add to the risks involved in investing in the space. Here are the pros and cons you should consider before diving in:
Pros of Tech Stocks
There are plenty of perks to investing in the tech sector. Some of the most significant include:
- Invest in What You Enjoy. Technology is an enjoyable topic for the majority of consumers, which makes investing in tech stocks fun. Successful investing involves detailed research. When you enjoy the topic of research, you’re more likely to do the intense research required to make educated investing decisions.
- Tremendous Growth Potential. Innovative technologies have the potential to lead to tremendous gains in value. There are three names that gained substantially in 2020 at the beginning of this article but there were several companies across the sector that saw similar gains. Educated investments in the tech sector have the potential to lead to significant gains in your investment portfolio.
- Options for Diversification. The tech industry is massive with several subcategories. Moreover, the industry covers a wide range of companies in different stages of business with different market caps. As such, there is plenty of room for diversification within the sector.
Cons of Tech Stocks
Although there are plenty of reasons to get excited about tech stocks, every rose has its thorns, and the tech category isn’t without them. Here are some drawbacks you should consider before investing in the space:
- High Valuations. Compared to other sectors, the tech sector is known for incredibly high valuations. In most cases, investors justify these valuations by pointing to the future value of innovative technology. Nonetheless, buying overvalued companies can be dangerous and lead to significant losses.
- High Volatility. Any time there’s potential for high short-term gains, there’s also likely quite a bit of volatility in the space. That is true among many tech stocks. Volatility is a measure of the fluctuations that take place in the prices of stocks. With high levels of volatility comes a certain level of difficulty when it comes to picking the best times for entrances into and exits out of these stocks.
- Tech Isn’t Known for Dividends. Although some companies in the technology industry do pay dividends, the vast majority of tech companies don’t. Most tech companies hold onto their profits to fuel research and development and continued innovation rather than sharing them directly with investors, and for good reason. Even a company that’s seemingly on top of the world in the tech industry will fall from its throne should it stop innovating. Just take a look at what happened to BlackBerry when competing smartphone companies like Apple stepped into the industry. If you’re looking for compelling dividends, tech isn’t where you’re likely to find them.
Where to Find Tech Stocks
Tech stocks can be found at both of the major US stock exchanges, the Nasdaq and the New York Stock Exchange (NYSE). Nonetheless, the vast majority of quality tech companies you’ll find will be listed on the tech-heavy Nasdaq.
You’ll also find plenty of tech stocks on the over-the-counter (OTC) market. However, if you’re a beginner, you’ll want to stay away from these stocks. The OTC market is filled with penny stocks that, for one reason or another, do not qualify for listing on the Nasdaq or NYSE. These stocks may seem promising, but they generally come with the following major risks:
- Reporting. OTC stocks are often nonreporting or underreporting. This means the financial data surrounding these stocks is generally outdated or incomplete.
- Speculation. The vast majority of stocks traded on the OTC market have business models that haven’t quite been proven. As such, these stocks are highly speculative bets, only adding to the risk.
- Capital Risk. Most stocks on the OTC market are undercapitalized and will need to reach capital markets to raise funds at some point. When this happens, these companies will generally do so through the sale of newly-issued shares, which is like slicing more pieces of the pie — including a sliver from your piece — causing existing shares to shrink in a process known as dilution.
- Volatility. Finally, while the tech sector is one that’s known for heavy volatility, that volatility is exacerbated when playing in penny stock territory, only serving to expand the risk.
Pro tip: If you’re going to add new investments to your portfolio, make sure you choose the best possible companies. Stock screeners like Stock Rover can help you narrow down the choices to companies that meet your requirements. Learn more about our favorite stock screeners.
Tech-Focused ETFs Are a Compelling Option for Beginners
If you’re a beginner investor or you simply don’t have the time to do the research it takes to pick stocks individually, you may want to look toward Nasdaq index funds, exchange-traded funds (ETFs), and mutual funds.
Nasdaq index funds are designed to mimic the movement of the tech-heavy Nasdaq composite index. So naturally, these are highly diversified choices to give you exposure to the tech sector. However, there are also plenty of ETFs and mutual funds that are geared exclusively toward the tech sector or subsectors. Some of the most popular include:
- Technology Select Sector SPDR Fund (XLK). The Technology Select Sector SPDR Fund is a highly diversified large-cap ETF designed to track the tech sector as a whole. The largest holdings in the ETF include Apple, Microsoft, and NVIDIA.
- Vanguard Information Technology Index Fund ETF (VGT). As its name suggests, the Vanguard Information Technology Index Fund ETF is an ETF that tracks an index of information technology companies. The ETF consists of small-, mid-, and large-cap companies and takes a heavily diversified approach to wider tech sector exposure.
- Fidelity Select IT Services Portfolio (FBSOX). Finally, Fidelity Select IT Services Portfolio is a highly diversified mutual fund. At least 80% of the fund’s assets are invested in companies that provide IT services. The fund’s primary objective is capital appreciation, seeking to invest in companies with high potential for future growth.
Investing in the tech sector can be incredibly lucrative. However, the wrong moves in the sector can also lead to significant losses. As such, before making any investment in the space, it’s important to do your research.
When looking for companies to invest in, look for companies that have a proven track record of innovation and a long-standing ability to stay on top of their subcategories. Also, pay close attention to valuations. Although tech stocks often carry high valuations, it’s important to make sure that the price you pay is on par with the rest of the sector.
When you do your research and make wise moves in the space, there are few other areas where you’ll find opportunities that are as impressive in terms of growth.