Patience is the key to profits in junior tech stocks

Technology has made extraordinary advances in the past decade, yet lots of investors lost money when they invested in it.

Often, that was because they invested too early. In their eagerness to get in on the “ground floor,” they bought tech stocks based mainly on potential improvements in the technology. But they failed to consider the political, financial and practical obstacles that new technology always faces.

Pioneering tech stocks rarely live up to their potential

Many investors are surprised to learn that pioneers in new or improved technology often make poor returns or worse. For instance, a number of software pioneers offered highly successful word processing and spreadsheet programs, but lost out to Microsoft’s Office suite of software, which offers both of these functions and more.

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Sony pioneered in videotape recording with its Betamax system, which was widely viewed as technologically superior to the VHS videotape system. But VHS triumphed and Betamax disappeared, mainly because VHS offered more storage on a single cassette.

Going back a couple of decades, the originator of hand-held electronic calculators, Rapid Data Systems, wound up going broke when sales of these devices first began taking off.

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Wait until tech stocks reach profitability before you buy in

Early-technology investing is an area where the interests of investors and brokers diverge widely. If you invest too early in new technology and the company runs out of money, it will have to raise more money to stay in business. The new investors are likely to extract much better terms from the company than the early investors.

In fact, new financing can rescue the company, but dilute the interests of early investors down to zero, or close to it. That’s why successful investors prefer to hold off on investing in tech stocks that are a long way from becoming profitable, regardless of their technology’s potential.

Brokers, in contrast, have an incentive to begin covering and recommending technology stocks much earlier in the process, regardless of the obstacles. After all, if the company goes through its initial stake and needs to raise more financing, it is likely to do so through the brokers who were first to recommend its stock.

One good rule is to wait until the company that owns the new technology is cash-flow positive — that is, bringing in more money than it is paying out. Better yet, wait till these tech stocks are profitable. That may mean you miss out on some huge profits that go to the earliest investors. But you’ll also miss out on the many junior tech stocks that never turn a profit — the ones that “crash and burn,” as the saying goes.

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