Investing in up-and-coming Canadian tech stocks, which often include hidden assets and research spending, can lead to big growth—but only if you select wisely

The best up-and-coming Canadian tech stocks are experiencing strong growth and expect to continue expanding. In fact, sometimes these technology companies 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 real estate, research and development spending or other valuable long-term assets.

All in all, 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.

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Here are four ways to pick the best up-and-coming Canadian tech stocks

With tech stocks, there are proven ways to increase your odds of success. Here are four important ones:

• Buy multi-product companies: Technological advances come in spurts, and they leapfrog each other. Focus on tech stocks that have some existing or soon-to-be-released products, and avoid one-hit wonders.
• Diversify: The high-tech sector has more than its share of winners and duds. So invest carefully and buy, say, 3 to 5 tech stocks instead of just one. Gains on your winners should overwhelm any losses you have.
• 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, lifted demand for faster, more reliable wireless networks.
• 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.

Spot hidden value with research and development spending in top up-and-coming Canadian tech stocks

Technology stocks have always been a more speculative segment of the stock market, but the technology shares with the greatest long-term potential are those that continue to make significant investments in research and development.

The investment odds are against you in a “hot” market—one whose investment appeal is widely, if not universally, recognized. And most tech stocks, even in a market like we’re in now, are still overpriced. This is because many investors have inflated ideas of their value.

But you can turn the odds in your favour by investing in tech stocks that have hidden assets, or assets that other investors overlook.

Hidden assets are items that don’t show up on a company’s balance sheet, but can offer dramatic rewards for investors who do their research.

Among technology stocks, research-and-development spending is today’s best-hidden asset. High research-and-development budgets let tech stocks keep adding profitable new products and improving existing ones.

Technology stocks have to treat this spending as a day-to-day expense, much like maintenance or taxes. So research spending comes out of the current year’s sales, and it lowers the current year’s earnings. As a result, earnings per share for tech stocks may appear lower than for stocks in other industries.

But, when done right, research and development spending pays off in dramatic long-term returns, both for high-tech companies and for those who invest in technology stocks.

Technology can be a plus for many stocks

People generally fail to recognize the large random element in the speed and payoff of technological progress. It’s totally unlike, say, a steady paycheque, or the interest you get from a savings account. It’s more like the growth of a healthy child. It also resembles the stream of dividends and capital gains that you get from owning a portfolio of high-quality stocks from most if not all of the five major economic sectors—the kind of stock portfolio we recommend to our readers, and create for our portfolio-management clients.

Many of our favourite high-quality stocks are not what investors would consider top tech stocks. However, these companies still profit from technology gains all the same, and they invest in new technology on their own schedule. They wait until the potential gains outweigh the costs in money and time to upgrade. Then they go for it.

New technology from the top tech stocks is percolating through the economy and into people’s lives, but in fits and starts, like any natural process. That process is gaining speed, but doing it so gently that people hardly notice. 

Up-and-coming Canadian tech stocks can expose you to higher risk

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, dividend-paying 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. 

How do you determine if a tech stock is right for your portfolio?