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'Tread carefully as technology stocks rise from the ashes'

This quote from a recent Sunday Telegraph article makes two obvious but critical points, writes Bob McDowall of Bloor Research.

Technology stocks are some of the major price gainers on the world stock exchanges in recent weeks; the second point questions the amount of confidence that may be placed by investors in technology stocks - memories of the late 1990's stock market boom, where technology stocks boomed louder than most and performed worse than most echoes the proverb "empty vessels make the most noise."

The fundamentals behind the rise require some further explanation. While there is no doubt that most technology stocks are cyclical in nature, in that corporations gear up their technology investment on the back of expansion of their core business, technology like all machinery needs replacing and upgrading periodically.

We are probably approaching one of those replacement cycles, even if economic expansion mode is another year or eighteen months away. Nevertheless, there is a so-called re-rating/re-evaluation of the sector by the investment community both because the sector suffered from excessive downgrading after the boom and because the market does anticipate recovery.

Both the institutions, which are entrusted to invest funds in the technology sector, and the technology sector itself, have lessons to learn in the next technology boom, before investors will regain underlying confidence.

The technology sector needs to:

  • Ensure product, services and performance forecasts and announcements are realistic. During the last technology boom, much of the sector became hostage to the marketing and public relations hype, which conveyed little of substance about the verifiable achievements and progress of the enterprises, their products and services, other than a permanent sense of perpetual optimism. No doubt the chastening failures and disappointments of the past four years will result in a more mature, realistic, sober approach to announcements and forecasts for the services.

  • subject its products and service to more extensive independent evaluation and comparative analysis and publish such reports, as a means of providing greater transparency to their sales and marketing messages.
  • Slow down delivery to market and provide more thorough review testing. Some of the largest firms such as Microsoft already recognise that they have rushed products and services to market under the increasingly discredited maxim of "first mover advantage." This results in muddled and frequent upgrades. There are no longer term benefits to such strategies. Reputations suffer. For the future the technology sector will find itself subject to regulatory control in the guise of consumer protection or financial regulation, as relevant to the technology products and services, are not more robustly and thoroughly tested prior to sale, delivery and implementation.
  • Establish greater community/industry responsibility. In a very young and competitive industry, it maybe forgotten that it is in the collective interest of the industry to develop and maintain integrity and reputation. More mature sectors recognise this, even though they may be competitors. This is for the greater good, and can drive out the less scrupulous members of he industry. Generally, the major firms have to take the lead.

The financial institutions, entrusted with investment of funds in the sector, are already experiencing changes to rules and regulations governing the organisational and reporting structures, as well as the conduct of their in-house analytical resource, but they may be reminded of the following:

  • Ensure they have a deep understanding of the products and services from which the technology companies derive or plan to derive their revenues. In a highly technical sector, without this background understanding and support to their analysis, the investment research is of very dubious quality and value.

  • Provide more comparative research and analysis. In an industry where there is a plethora of new products and services, it does help the investment decision process to have relevant technical and financial comparisons, despite the sensitivity of the industry to such exercises.

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