Canadian tech stocks need more than technological breakthroughs to fuel their growth, and not all of them benefit from those advances in the same way and to the same extent

Increasingly, the most successful firms at profiting from technology improvements have scale and a strong market position. There are also other factors to look for.

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What investors should know about selecting the best Canadian tech stocks

• A strong reputation helps win new contracts.
• High cash and low debt aids new product development.
• High research and development budgets let tech stocks keep adding profitable new products to their lines and improving existing ones.
• 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.
• Is there a history of success?

Smaller Canadian tech stocks may struggle to take advantage to breakthroughs

It often takes a much bigger company to be able to buy and profit from today’s technological advances. Here are some examples:

• Robotic workers have been around for a number of years. In a joint venture with IKEA, a Swedish construction firm uses a robot-equipped factory to build ready-made rooms. On construction sites, workers assemble the rooms into homes like LEGO toys. The process cuts construction costs by 35%, and reduces building time by up to 50%.
• Automated warehouse systems that can pack and ship an order, untouched by human hands. Amazon was a pioneer in this area. Now it’s almost common at big companies. Few small companies can afford it.
• For some time, artificial-intelligence-equipped phone systems have been able to ask questions, understand callers’ spoken answers, and transfer calls to the appropriate department. Today, more advanced models can handle routine calls such as booking appointments without human intervention. Soon, artificial-intelligence chat lines will routinely tell you how to install software or fix computer problems.

These advances are still out of reach for most small companies. Fortunately, prices of new technology inevitably fall, as entrepreneurs find new ways to package it for sale. The latest technology will often find its way into smaller companies through cheaper, simpler versions of today’s breakthroughs.

What the best Canadian tech stocks will do for your portfolio

The best Canadian tech stocks have strong growth prospects and can also become so successful that they start paying dividends. As well, investors should scour a technology stock’s balance sheet for any indication of hidden value like research and development that will pay off in the future.

Note that we don’t say that all companies that spend money on research and development are “more profitable than they appear”—far from it. Nor would we say that all these companies offer or are building up hidden value. We only say that about companies that we feel are: 1) Spending their research dollars in a prudent and potentially profitable fashion, and 2) Sufficiently well-managed, well-financed and well-situated (in relation to competitors, their market and so on), and 3) Able to exploit whatever advances their researchers come up with. Spotting these companies is an art, as much as a science.

Remember, Canadian tech stocks are subject to volatility

Successful tech stocks can experience enormous growth. However, technology stocks are also susceptible to lots of market volatility—and negative news can throw tech stocks into steep declines.

If you’re going to hold Canadian tech stocks in your portfolio we recommend that you only hold the very best—such as the stocks we recommend in our newsletters. We also recommend using our three-part Successful Investor approach for your overall portfolio:

• Invest mainly in well-established companies;
• Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; the Consumer sector; Finance; Utilities);
• Downplay or avoid stocks in the broker/media limelight.

Bonus: Four ways to pick the best “pennies” among Canadian tech stocks

With tech penny stocks, there are proven ways to increase your odds of success:

1. Buy multi-product companies: Technological advances come in spurts, and they leapfrog each other. Focus on tech penny stocks that have some existing or soon-to-be-released products, and avoid one-hit wonders.
2. Diversify: The high-tech sector has more than its share of winners and duds. So invest carefully and buy 5 to 10 tech penny stocks instead of just one. Gains on your winners should overwhelm any losses you have.
3. Focus on up-and-coming technologies: To do this, you need to know how technology is changing. For instance, the immense popularity of wireless devices, like the iPhone and tablet computers, stepped up demand for faster, more reliable wireless networks.
4. Look for earnings: A perpetual money loser will eventually go broke, no matter how impressive its technology. But if it makes even a little money, it can stay in business and perhaps reap the bonanza of a new product.

To what extent have you focused on global tech leaders as opposed to Canadian tech stocks?