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Most investors who focus on valuation have a hard time figuring out what to do with technology stocks.
Tech companies rarely trade for the low measures of earnings and asset value that are the traditional hallmarks of value-oriented investors.
The average PE ratio of a tech stock going back 40 years is an eye-popping 32, so that's not really going to pop up on a value-oriented screen.
To complicate things further, many tech stocks (including leading companies in the sector) don't show a profit, so traditional value and even some growth investors pass on what turns out to be a monster of a stock.
But you know I'm not your traditional investor.
I'm always on the hunt for new and innovative investment strategies ideas, and recently I've made some wildly profitable discoveries that I want to share with you…
Cracking the Code for Tech Value
I have worked on the tech puzzle for years and found a few things that work very well with tech stocks and allow me to sleep at night without fretting over the valuations of the companies in the portfolio at any given time.
Not too long ago, I shared the tech free cash flow model that only buys stock with low price-to-free cash flow and offers outsized returns.
The only problem with that approach is that it only produces a few stocks at any given moment in time.
So, unless you have a considerable appetite for volatility, you cannot get a large percentage of your portfolio in tech stocks.
Recently I have put a lot of time and attention into deciphering the tech stock equation.
After all, technology is the most exciting part of the economy.
All the hot topics and trends come from technology stocks. Things like artificial intelligence, driverless cars, robotics, the Internet of Things, and other advances are changing the world we live in at a rapid rate.
Like everyone else on the planet, I don't want to sit back and watch all this happen without some of the massive profits from all this finding its way into my pockets.
For all this to work, a couple of things have to happen for me to be able to be intellectually comfortable with a tech-focused strategy.
First, I have to be buying the companies at what presents a bargain price compared to the actual value of the company.
If I ended up purchasing companies at inflated prices relative to a reasonable measure of the companies' worth, I'd break out in hives.
Second, it has to be quantitative in nature to remove all of the wishing and hoping from the equation.
Survival of the Fittest
I tried a lot of different ideas, but as is usually the case, only a few survived the rigorous testing.
The good news is that the few that made the cut outperform in a very impressive fashion.
As seems to be the case most of the time, the simpler I kept things, the better the models worked. Over the years, I've learned to trust pure, raw math far more than opinions.
The simplest model turns out to be one of the best.
Just buying tech stocks that pass my financial health checklist and have a dividend yield of 3% or more crushes the stock market over the past two decades.
Every $10,000 invested using just those simple rules would have grown to $112,300, while the same amount in the S&P 500 would be only $35,001.
The only problem with this model is that – much like the free cash flow tech model – we only find an average of five companies at any given time.
To put together a full portfolio of tech stocks, we will need to combine a few methods, but free cash flow and now dividends give us a good start at accomplishing that goal.
Right now, the model is pretty generous and there a total of seven tech companies that are financially sound and pay a generous dividend.
About the Author
Tim Melvin is an unlikely investment expert by any measure. Raised in the "projects" of Baltimore by a single mother, he never attended college and started out as a door-to-door vacuum salesman. But he knew the real money was in the stock market, so he set sights on investing - and by sheer force of determination, he eventually became a financial advisor to millionaires. Today, after 30 years of managing money for some of the wealthiest people in the world, he draws on his experience to help investors find "unreasonably good" bargain stocks, multiply profits, and build their nest eggs. Tim tirelessly works to find overlooked "hidden gems" in the stock market, drawing on the research of legendary investors like Benjamin Graham, Walter Schloss, and Marty Whitman. He has written and lectured extensively on the markets, with work appearing on Benzinga, Real Money, Daily Speculations, and more. He has published several books in the "Little Book of" Investment Series and a "Junior Chamber Course" geared towards young adults that teaches Graham's principles and techniques to a new generation of investors. Today, he serves as the Special Situations Strategist at Money Morning and the editor of "Max Wealth" and Heatseekers.