The 10 Best Technology Stocks for Long-Term Investors

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Microprocessor
Image credit: Yaca2671, via Wikimedia Commons.
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This guide is based on the thesis that long-term investment outperformance in the technology industry rests on buying and holding shares in companies that have sustainable competitive advantages in their market niche and have the long-term technology trends moving in their favor. The basic investing truisms such as diversification, investing for the long-run, and buying shares at a reasonable valuation continue to apply. This guide looks first at the trends affecting the technology industry before building a list of companies with outsized long-term potential.

Technology sector outlook

Trends

1. Mobile devices

The rise of the mobile phone—and especially the smartphone—is probably the most obvious current technology trend. Nielsen estimates that U.S. smartphone penetration is 70% as of mid-2014; average hourly smartphone usage increased over the previous year. Business Insider estimates that mobile advertising will have a 5-year compound annual growth rate (CAGR) of 49.7% in 2018.

Along with the smartphone has come the rise of mobile apps and the mobile Internet. With LTE, mobile Internet speeds are not far behind landline Internet speeds. Phone processing power, battery life, and screen size continue to increase. Smartphones are increasingly replacing PCs for common computing tasks such as web browsing.

According to IDC, Google's Android OS holds almost an 85% worldwide market share among smartphone operating systems as of late 2014. This market share continues to grow while Apple's iOS continues to lose ground. Apple remains by far the most profitable company in the smartphone space. Samsung has long been the leading smartphone manufacturer, but is far less profitable than Apple. Virtually all smartphones use ARM microprocessors. Electronic components manufactured by Qualcomm are pervasive among smartphones as well.

Another mobile trend is tablet computers, such as the Apple iPad, Samsung Galaxy Tab, Google Nexus 7, Amazon Kindle Fire, and Microsoft Surface. Sales of Apple's pricey iPad appear to have slowed, but other brands are going strong, with technology research firm Gartner projecting global growth at 38.6% in 2014. Tablet growth is strongest outside the U.S., where poorer consumers see generic-brand tablets as a more affordable alternative to personal computers.

An emerging trend among mobile devices is wearable computers such as Google Glass and various smart watches, such as the Pebble, the Samsung Gear, the Motorola Moto 360, and the Apple Watch.

The biggest beneficiaries of the mobile computing trend include Apple, Google, Samsung, ARM Holdings, Qualcomm, Verizon, AT&T, Sprint, and T-Mobile. Microsoft and Intel, the two companies that dominated the PC industry for decades, have been largely left behind in the mobile devices era. Microsoft holds a distant third place position in mobile device operating systems. Intel was virtually non-existent in the space until it secured a contract to supply microprocessors for Google Glass.

2. Machine learning and big data

Machine learning and big data are two closely related subjects. Machine learning uses statistics and advanced algorithms—like support vector machines (SVM), neural networks, and Bayesian reasoning—to make predictions based on previously gathered data. Two important applications of machine learning are information retrieval and natural language processing. Information retrieval is the academic name for what is commonly known as "search". Natural language processing is the ability of computers to understand and respond to human language. The effectiveness of machine learning systems is dependent on both the sophistication of their algorithms and the quantity of data they can learn from. Access to massive amounts of data (i.e. "big data") makes machine learning systems more intelligent.

Big data refers to datasets so massive they cannot be processed on a single computer or with ordinary software tools. Big data is often unstructructured, unlike the organized and structured data people normally work with. Apache Hadoop, the leading open source software tool used for processing big data, is based largely on research papers published by Google. Yahoo, Facebook, and numerous smaller tech firms wrote much of the code for Hadoop. Another open source tool used for processing big data is Apache Cassandra, developed by Facebook.

Google appears to have an insurmountable lead in the field of machine learning. Google, Facebook, Microsoft Bing, and Yahoo are leading aggregators of big data in the tech sector. Leading providers of big data information technology services include IBM, Cloudera, MapR, and HortonWorks.

3. Streaming media

According to the NPD Group, 17% of U.S. households with Internet access owned stand-alone streaming media boxes in Q2 2014. That number is expected to more than double, to 39%, by 2017. These numbers don't include the widespread penetration of other streaming media devices, such as game consoles, smart TVs, and smart Blu-ray players. Netflix, the leading streaming video provider, already has 36 million customers in the United States and is producing its own content, like the TV series House of Cards.

Leading streaming video services include Netflix, Amazon Instant Video, Hulu, and Google's YouTube. Pandora and Spotify are the leaders in streaming music. Streaming video devices include game consoles (Sony PS4, Microsoft Xbox One), streaming video boxes (Roku, Apple TV), and smart TVs (Samsung, LG, Sony). Intel microprocessors are found inside the current generation of gaming consoles. ARM-based microprocessors—such as the Qualcomm Krait and Broadcom Merlyn—are common in streaming media boxes and smart TVs.

4. Cloud computing

Mobile devices, big data, and streaming media are collectively leading to the rise of another trend: cloud computing. Cloud computing involves massive data centers at major tech firms that make data storage and processing power available via the Internet.

Cloud computing solves various problems simultaneously. First, ordinary people often need to share documents and other data between multiple computing devices, such as their personal computer and their smartphone. Cloud computing gives them a central data repository they can access from anywhere in the world. Second, big data processing requires hundreds or thousands of computers operating in parallel. Cloud computing makes it easy for companies and researchers to set up big data processing systems without having to build their own hardware infrastructure. Third, cloud computing allows companies to set up geographically distributed streaming media services that minimize the load on the Internet's communications infrastructure. Finally, cloud computing makes it easy and inexpensive for small companies to set up and maintain a highly reliable website.

Major players in this space include Amazon Web Services, Rackspace, Dropbox, Microsoft Azure, a multitude of Google services, Apple iCloud, and Red Hat OpenShift.

5. Information technology services

Many large organizations are in need of customized information technology solutions. IT service firms fill these needs. This is an unexciting and slow growth part of the tech sector, but likely to remain steady for many years to come. Leading companies in this market include IBM, Hewlett-Packard, Cognizant, and Computer Sciences Corporation. Two leading Indian information technology service firms that trade on the New York Stock Exchange are Infosys and Wipro.

Countertrends

1. The personal computer

The rise of mobile devices is a long-term threat to the personal computer and companies that are PC-dependent, such as Microsoft, Intel, and Adobe. Intel seems most vulnerable, as it has so far been unable to establish a beachhead in the market for mobile device microprocessors. According to technology research firm Gartner, global PC sales fell 10% in 2013. In March 2014, Gartner projected sales would fall another 6% in 2014 and 5% in 2015. A year later, data from IDC confirms that this downward trend for PCs is continuing. Smartphones are overtaking personal computers as people's primary computing device.

2. Landline phones

According to the U.S. Census Bureau, 25% fewer U.S. households had landline phones in 2011 than in 1996. In 1996, 96% of U.S. households had landline phones; by 2011 it was down to only 71%. Today, more U.S. households have cell phones than landline phones. The trend of dropping landline phones in favor of mobile phones is strongest among millenials. As they age, larger and larger portions of the U.S. adult population will be landline-free.

3. Cable TV

Streaming media is a long-term threat to cable TV today, just as cable TV was a threat to broadcast TV decades ago. Streaming media is unlikely to replace cable TV, but it will grab an increasing share of the television viewing audience at cable's expense. Cable is already losing customers to streaming media companies. In mid-2014, cable companies were losing video customers at a rate of 300,000 per quarter. As streaming media grows in popularity, especially with younger audiences, this rate of customer defections could increase significantly.

4. Buying music and movies

Music sales have been in decline for a long time now. First, compact discs were replaced by digital music downloads. Now digital music downloads are being replaced by streaming music services, such as Pandora and Spotify. Likewise, streaming video services like Netflix and Amazon Instant Video are increasingly cutting into sales of Blu-ray discs. Today's trend is to stream music and movies rather than buy them outright.

Stock picks

Investment thesis

The following list of stocks is based primarily on the sustainable competitive advantages, market trends, and proven performance of the companies. It favors companies that are leading the technology curve, and avoids those that are falling behind.

This is a list of outstanding publicly-traded companies in the technology sector that should be a great investment if purchased at an attractive valuation. It is not a suggestion that they are necessarily a great investment at their current stock price. As I write this, some stocks on the list are very pricey, such as Netflix, Amazon.com, Facebook, and ARM Holdings, while others on this list appear to have much more reasonable valuations.

The list of the 10 best tech stocks

Click the name of any company on the list to see a chart of its long-term stock performance.

1. Facebook

Facebook is by far the world's largest social network, with over a billion monthly average users. According to Alexa, Facebook.com is the second-most popular site on the Web. Facebook has a near-monopoly position in friend-based social networking. It also owns Instagram and is acquiring WhatsApp. Facebook's network effects and its scale give it a strong sustainable competitive advantage. In addition, it has done a great job of adapting to the rise of smartphones. Instagram, WhatsApp, and Facebook Messenger strengthen the company's lock on smartphones. Facebook's revenue comes almost entirely from Internet-based, targeted advertising.

Sustainable competitive advantage: None Weak Strong

As of , Facebook is rated 4 stars by S&P and 2 stars by Morningstar. Check with your brokerage firm for the latest recommendations.

2. Apple

Apple is a great company with great management. Lots of people have made a lot of money investing in Apple. Apple has a weak sustainable competitive advantage that makes it a riskier bet than most other stocks on this list. By increasing the seamless interoperability of Apple's product lines, CEO Tim Cook appears to be taking the company in a direction that should strengthen its sustainable competitive advantage by locking customers into the "Apple experience". While it has dominated competitors in many product lines—MP3 players, digital downloads, personal computers (especially lightweight laptops), smartphones, and tablets—for well over a decade now, its current profits are highly focused on a single product line: the iPhone. So far, this riskier bet has paid off great for investors, but predicting its future is difficult.

Sustainable competitive advantage: None Weak Strong

As of , Apple is rated 3 stars by S&P and 3 stars by Morningstar. Check with your brokerage firm for the latest recommendations.

3. Amazon.com

Amazon is best known as the world's leading Internet retailer. Its U.S. website ranks sixth in the world. Amazon also designs and sells electronics under the Kindle and AmazonBasics product lines. Amazon Web Services (AWS) is one of the world's largest web hosting providers. Amazon sells downloadable audiobooks via Audible.com and Apple's iTunes Store. Amazon also owns online shoe and clothing retailer Zappos.

Amazon.com has a near-monopoly position in online retail and a market-leading oligopoly position in enterprise web hosting. It also dominates the market for e-books. Its Audible subsidiary dominates the market for downloadable audiobooks, a growing portion of the book market. 60% of Amazon's revenues come from North America, with the other 40% coming from international operations.

Sustainable competitive advantage: None Weak Strong

As of , Amazon.com is rated 3 stars by S&P and 4 stars by Morningstar. Check with your brokerage firm for the latest recommendations.

4. Netflix

Netflix is riding the tech wave of Internet-based video streaming. It is the market leader, but faces competition from Amazon Instant Video, Hulu, and HBO. It is questionable whether Netflix has any sustainable competitive advantage whatsoever, but the recent complete failure of Verizon's Redbox Instant to gain any traction against established players bodes well for Netflix.

Although Netflix has little or no sustainable competitive advantage today, it will likely develop a weak sustainable competitive advantage as it develops more original content. The trick for Netflix will be to develop popular original TV shows faster than competitors can gain a foothold in the market. As of this writing, Netflix is a very expensive stock. Its extreme volatility over the past five years suggests there may be a possibility to buy it as a reasonable price in the future, if you wait to buy when other investors are fearful.

Sustainable competitive advantage: None Weak Strong

As of , Netflix is rated 3 stars by S&P and 3 stars by Morningstar. Check with your brokerage firm for the latest recommendations.

5. Google

Google is the single best tech company from a sustainable competitive advantage point of view, because its competitive advantages are diversified across numerous product lines. This means it has less downside risk than other companies on this list. Google has near-monopoly positions in search and online video. It has market-leading oligopoly positions in mobile operating systems, online advertising, and web-based email.

Google operates two of the world's three most popular websites, Google.com (#1) and YouTube.com (#3). According to Digital Trends, the Google search engine has a 69% global market share, ahead of Baidu (18%), Yahoo (7%), and Microsoft Bing (5.5%). Google's Android is the world's most dominant smartphone operating system, with an 84% global market share according to IDC. Although technically open source, Google has a virtual lock on Android to the point that Ars Technica argues it's unforkable. Google's AdWords and AdSense dominate the market for online advertising. Google's YouTube is the leading source for user-generated, web-based video. Its GMail service is the market leader in web-based email, ahead of Outlook.com and Yahoo Mail.

Sustainable competitive advantage: None Weak Strong

As of , Google is rated 5 stars by S&P and 3 stars by Morningstar. Check with your brokerage firm for the latest recommendations.

6. ARM Holdings

ARM Holdings was founded in 1990 as a joint venture between Acorn Computers, VLSI Technology, and Apple. ARM stands for "Advanced RISC Machines." RISC, in turn, stands for reduced instruction set computing, a description of the microprocessor architecture. ARM Holdings designed the microprocessors for early personal digital assistants such as the Apple Newton; today its microprocessor architecture appears in virtually all smartphones sold.

ARM Holdings has a monopoly position in the intellectual property for smartphone microprocessors. This gives it a very strong sustainable competitive advantage. ARM Holdings does not manufacture microprocessors itself, but instead licenses its intellectual property to microprocessor manufacturers like Qualcomm, Samsung, Broadcom, and Freescale Semiconductor. As of this writing, ARM Holdings is an extremely expensive stock and may not be worth buying for that very reason.

Because Google's Android operating system is basically hardware-independent Java running on top of Linux, Android apps aren't as dependent on the underlying microprocessor architecture as traditional software applications are. This makes Google, and Android-based smartphone manufacturers like Samsung, less "locked-in" to the ARM architecture than they otherwise would be.

Sustainable competitive advantage: None Weak Strong

As of , ARM Holdings is rated 3 stars by Morningstar. Check with your brokerage firm for the latest recommendations.

7. Qualcomm

Qualcomm, short for "Quality Communications," owns much of the intellectual property behind CDMA, a technology found in many of the world's mobile phones. This gives the company a strong sustainable competitive advantage.

Qualcomm makes the majority of smartphone integrated circuits sold today. Its baseband processors are found in Apple's iPhones and iPads. Its ARM-based Krait CPU and Snapdragon system-on-a-chip product lines are the smartphone market leaders, found in high-end Android phones and all Windows Phones. Qualcomm ranks second in microprocessor market share, far behind Intel but ahead of Samsung and AMD. It is growing much faster than Intel. If you feel the P/E ratio of ARM Holdings is too high to stomach, Qualcomm—as the leading ARM processor manufacturer—is an attractive surrogate.

Sustainable competitive advantage: None Weak Strong

As of , Qualcomm is rated 5 stars by S&P and 3 stars by Morningstar. Check with your brokerage firm for the latest recommendations.

8. Microsoft

Microsoft has a virtual monopoly in PC operating systems and office software. These make up the core of the company's profits. Its largely unprofitable Xbox family of game consoles compete in a duopoly with Sony's PlayStation family. With its IIS web server and Azure cloud computing platform, Microsoft holds a strong position in the enterprise computing market.

The rise of the smartphone and the subsequent decline of PCs has become a significant headwind for Microsoft. Microsoft trails far behind Google and Apple in the market for smartphone operating systems, but Microsoft seems determined to persevere. Microsoft became a major smartphone maker when it acquired Nokia's Devices & Services business on April 25, 2014. With the Microsoft Surface, the company is also determined to be a player in the tablet computing market. Only time will tell if Microsoft is successful in its attempts to be a major player in mobile devices. Although Microsoft is still growing at a healthy pace, the decline of the PC gives it more downside risk than other companies on this list.

Microsoft is one of only three U.S. companies with a AAA credit rating. The other two are Johnson & Johnson and Exxon Mobil.

Sustainable competitive advantage: None Weak Strong

As of , Microsoft is rated 3 stars by S&P and 3 stars by Morningstar. Check with your brokerage firm for the latest recommendations.

9. Intuit

Intuit is by far the leader in personal finance and small business software. It is a company with steady moderate growth. Intuit's main product lines are TurboTax, QuickBooks, and Quicken. 47% of Intuit's revenue comes from its Tax division, 45% comes from its Small Business division, while the remaining 8% comes from "other businesses." High customer switching costs give Intuit a strong sustainable competitive advantage.

The Tax division is a mature and stable business, with little upside potential but also little downside risk. As of 2012, 80% of U.S. tax returns are filed electronically. Since Intuit's TurboTax is the longstanding market leader in tax preparation software, this gives it little room to grow in an already saturated market. Although growth is limited, tax software provides an income stream as reliable as the calendar.

The Small Business division provides most of Intuit's growth opportunities. The diversity of small business needs creates a broader array of exploitable market opportunities. Intuit's small business solutions fall into three categories: Financial Management Solutions (20% of company revenues), Employee Management Solutions (14% of revenues), and Payment Solutions (11% of revenues).

Intuit is in the process of moving away from standalone software packages in favor of cloud-based software-as-a-service solutions. This should provide an even more reliable and continuous income stream in the future. While Intuit has long served the do-it-yourself market, the company is also increasingly providing software solutions for service professionals, such as accountants.

Sustainable competitive advantage: None Weak Strong

As of , Intuit is rated 3 stars by S&P and 2 stars by Morningstar. Check with your brokerage firm for the latest recommendations.

10. Verizon Communications

Technically, phone and cable companies are considered part the communications sector, not the technology sector. That distinction dates back to when analog phones and televisions had little to do with computers. But it's a digital world now. With smartphones and the Internet being integral to today's computer industry, I felt it was appropriate to include a leading data communications provider on this list.

Verizon is a slow growth company that is the best of breed in both landline and wireless communications services. Verizon's landline phone, Internet, and TV communications infrastructure are part of a duopoly in virtually every market it serves. Meanwhile, the company's Verizon Wireless subsidiary has a market-leading oligopoly position in wireless communications. Early in the days of mobile phones, Verizon Wireless played a very smart bet by outbidding its competitors for the best wireless spectrum—spectrum with wavelengths long enough to easily travel through walls. Verizon Wireless also invested more heavily in wireless infrastructure than its competitors. Now Verizon Wireless can provide better services than competitors, and charge a premium price for that better service. Verizon's network effects and best-of-breed telecommunications infrastructure give the company a weak sustainable competitive advantage.

Sustainable competitive advantage: None Weak Strong

As of , Verizon Communications is rated 3 stars by S&P and 3 stars by Morningstar. Check with your brokerage firm for the latest recommendations.

Bonus suggestion!

To get a free bonus investment suggestion, click the Google+ button:

Bonus: Technology Select Sector SPDR ETF

If you want to invest specifically in the tech sector as part of a diversified portfolio, one option that is much easier than researching individual stocks is to invest in a tech sector exchange-traded fund (ETF).

The Technology Select Sector SPDR ETF is the largest technology exchange-traded fund. It is recommended over individual stocks because of its diversity. As of this writing, its top ten holdings consist of:

  1. Apple
  2. Microsoft
  3. Verizon
  4. AT&T
  5. IBM
  6. Google
  7. Facebook
  8. Intel
  9. Oracle
  10. Qualcomm

Disclaimer

I cannot predict the future—and neither can anyone else

Predicting which stocks will do well in the future is extremely hard. That's why most mutual fund managers fail to beat the performance of index funds. That's why I recommend investing in index funds or ETFs over individual stocks. But if you are going to invest in individual stocks, it is safest to invest in companies with sustainable competitive advantages that protect their profits from market competition.

Further reading

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