Tech stocks have been some of the best performers in the market so far this year. Technology, as measured by the SPDR Technology Select ETF (XLK), is up 24.5% for the year.
The broader tech-heavy Nasdaq is up more than 19%. As most investors are no doubt aware, the emergence of artificial intelligence (AI) has been a major driver of that outperformance.
Not only has the AI trade fueled growth in chipmakers, data center operators, and the assorted tech companies that enable these massive server farms, it has also fueled a major rally in the energy companies helping power it all.
And now, with interest rates on the decline again, the odds are rising that smaller tech companies that are less leveraged to AI will start outperforming as well.
That means “tech stocks” in areas like biotech, financial tech, educational technology, engineering software, and so on could once again have room to grow.
Tech stocks, in general, tend to operate on the cutting edge, which means higher risks and higher rewards. You don’t get fast, seemingly unlimited growth without a share of risk.
They can also be some of the biggest names in the economy or micro-cap startups.
But when you put all those differences aside, the best tech stocks all share some common traits.
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The Defining Characteristics of the Best Tech Stocks
As a whole, technology stocks have been moving up faster than the general market. The Information Technology sector of the S&P 500 has outperformed the index itself by more than 40 percentage points in the last five years.
In the future, there is a good chance tech sector performance will be even more dominant than it has been. So how do you get in on this?
The best tech stocks, or for that matter, the best stocks in any industry, have a few common traits:
- The company has a product, service, or business model that is revolutionary.
- Their offering has mass-market appeal.
- The company has plenty of room to grow and is likely already fast-growing.
- The stock has strong RP lines, positive earnings, and reasonable valuation (meaning it’s not overpriced).
- And last but not least, it has a stock that’s trending up, indicating that investors’ perceptions of the company are improving.
Don’t Overlook the Old-Fashioned Tech Stocks
While they might seem “boring,” there are plenty of older tech stocks that also pay dividends, which is almost always a good indicator of a quality stock. (Just be aware that a dividend alone doesn’t make a stock a good purchase. There are dividend stocks out there hanging on by a thread and don’t have very promising-looking futures.)
There’s Microsoft (MSFT), which has grown earnings by an average annual rate of better than 20% for the past five years. That’s astounding growth for an industry behemoth. The stock has returned an average of nearly 28% per year over the same period. And the company has persistently raised its dividend for the last decade.
Or consider a stock like International Business Machines (IBM). Despite the success of the company’s “Watson” AI (which appeared on Jeopardy! all the way back in 2011), the firm had been an afterthought in the early days of the AI rally.
But investors have warmed up to IBM lately (the stock has doubled in the last two years), partially due to the company’s impressive AI bona fides and partially due to its potential on the quantum computing front.
At the same time, in 2020, IBM was added to the list of Dividend Aristocrats, meaning it has raised its dividend yearly for 25 consecutive years (currently paying 2.37%). So while it may not be the purest play on the AI data center buildout, it’s one of the few tech stocks that can also boast membership in that exclusive club of dividend payers.
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*This post is periodically updated to reflect market conditions.