Some investors seek out a ground-floor investment in tech because of strong growth potential, but more often than not, these investments don’t work out for them

Some aggressive investors like to get into fast-growing stocks at what they describe as “the ground floor.” They think the best way for Successful Investors to profit in stocks is to buy them when they are just barely starting out on a growth phase that can last for years if not decades. Ideally, they want to buy the future top performers when they are still near or close to the penny stock range and have yet to be discovered by the broad mass of investors.

However, they rarely find what they’re looking for in a ground-floor investment. That’s because there’s a large random element in investing, especially at the ground floor. Many promising junior stocks fail to thrive as businesses for one or more of any number of reasons. To borrow from the opening lines of Tolstoy’s Anna Karenina, successful stocks tend to have a lot in common, whereas unsuccessful stocks tend to suffer from their own unique sets of risks and faults.

For a rising portfolio Learn everything you need to know in 'How to Find the Best Growth Stocks' for FREE from The Successful Investor. Canadian Growth Stocks: CGI Group, CAE Inc., Fortis Inc. Stock and more.  I consent to receiving information from The Successful Investor via email. I understand I can unsubscribe from these updates at any time.

Why a ground-floor investment is destined to fail

Sometimes stocks with intriguing business concepts just never get anywhere. They generate a number of encouraging news releases, but these releases turn out to be a series of exaggerations and broken promises.

Promising stocks may start out with a brilliant idea or a plan to get involved in a high-profile or fast-growing business area. They may enjoy an initial burst of sales or even earnings. But many just can’t keep up the momentum. They never reach the critical mass they need to achieve consistent profitability.

This is very common in junior techs, because they compete with well-established, well-financed senior techs. The seniors have an enormous advantage in well-trained staff, sales networks, media contacts and all sorts of other business assets that can take years, if not decades, to develop.

You compound your risk if you invest in a promising junior that is a “thin” or illiquid trader. When a stock is a thin trader, it doesn’t take much buying or selling to influence its price. So if just one important investor decides to sell, it can cause an abrupt stock-price slump. This can spark a cascade of selling and a collapse in the stock’s price. The resulting stock downturn can scare off other potential investors. This can make it impossible for the formerly promising junior to raise additional funds when it needs them.

What to consider if you want to make a ground-floor investment in tech

Tech stocks are companies that are involved in the research, development and production of technology such as electronics or software. With high research and development budgets, tech stocks rarely pay dividends and are typically classified as growth stocks.

Technology stocks tend to be riskier than other manufacturing firms. That’s because demand for their products is cyclical, and they must spend heavily on research and development. Even then, there’s no guarantee their efforts will boost their sales or protect them from start-ups with better technology.

4 key risks of investing in hot growth stocks and ground-floor investment opportunities in the tech industry

Marketing is as hard as inventing: Even a great new product or computer program may fail to overcome the skepticism of retailers and consumers.

Acquisitions can bring “time-bomb” risk: Companies sometimes grow quickly by buying other companies. But it may also be the case that those selling the companies may simply want to bail out of a losing situation.

Major tech stocks also make mistakes: Hot growth stocks in tech that are new technologies often trumpet their deals with major firms, such as Apple or IBM. And it’s true that Apple and IBM have vastly more knowledge and bargaining clout than any individual investor. But they still invest in products that fail.

Be wary of high-tech shams: It’s easier to set up a company and sell stock to investors than it is to perfect a technological breakthrough. Be especially wary when new technology stocks splurge on elaborate websites and glossy investor brochures.

Investing in the best tech stocks while avoiding a ground-floor investment

The best tech stocks have strong growth prospects. The best technology companies can also become so successful that they start paying dividends. Investors should also scour a technology stock’s balance sheet to glean any hints of hidden value like research and development.

The success or failure of any tech stock depends on a variety of factors. The company may start out with a promising business plan. But it needs all sorts of things to prosper in the long run: the right employees, a favourable economic and regulatory climate, a favourable competitive environment, favourable research outcomes, adequate financing, perhaps the right merger partner or acquisition—the list is long.

What Successful Investors need to know when selecting the best tech stocks:

• High research and development budgets let tech stocks keep adding profitable new products to their lines and improving existing ones.
• High cash and low debt aids new product development.
• A strong reputation helps win new contracts.
• Often tech stocks will offer different classes of shares that come with various shareholder voting rights. (Investors can save money by purchasing the lower priced shares although they give up some rights).
• Most quality companies have a history of success.

All in all, follow our Successful Investor philosophy to pick better growth and tech stocks.

What ground-floor investment opportunities have worked well for your portfolio?

When new investors ask you about ground-floor investment opportunities, what advice do you give them?