Three Reasons to Buy Tech This Year
By Porter Stansberry
March 20, 2008
There are lots of businesses you should almost never buy.
Take the onshore gas and oil-well drilling equipment business, for example. These companies design, manufacture, and own very expensive drilling equipment. Oil companies don't want to spend the money to buy and maintain these rigs, so they rent them by the day. The rental prices are correlated to oil prices – which are notoriously volatile. Thus, for the drill-rig firms, it's either feast or famine.
When times are good, every last rig will be rented, each delivering tens of thousands of dollars every day. When times are bad, most of the rigs will be sitting in storage, rusting. Whether they're rented out or not, the mortgage on the rigs – the capital costs – must be paid. That's exactly why most oil and gas companies don't bother owning their own drills. Over the course of a market cycle (five to seven years), owning rigs is too expensive.
The combination of highly volatile demand, huge capital costs, a large number of employees, and generally tight profit margins makes the onshore drill-rig business a very tough one.
The industry's history is filled with booms and busts – and plenty of bankruptcies. The only time to buy these stocks is when no one wants to rent a rig and the entire industry looks like it's going out of business. Of course... investors tend to ignore these stocks at those times and buy these shares when their earnings are good, which, more often than not, is very near the top of share prices.
If you're only interested in compounding your wealth and owning stocks that you don't have to think about or watch closely, you shouldn't try to buy into these sectors, ever. On the other hand, I think it's worth trying to time these cyclical industries, because knowing the fundamentals of the business can give you a definitive edge. These things will boom, regularly. But you must remember, companies like these are not good long-term investments. You have to know when to get onboard and when to jump off.
Now, I'm not recommending you buy the oil and gas drillers. I think the best opportunity you have right now with this kind of trade is in telecom equipment makers...
Like a rig-building company, telecom equipment makers do all of the capital-intensive work telecom companies don't want to waste money on. And making the business even tougher, the technology that enables this equipment is constantly improving.
Imagine trying to build $10 million oil and gas rigs when every five years, your rig has to become 10 times more efficient just to remain competitive. Thus, not only do the telecom-equipment firms face huge capital costs, they must also invest heavily in research and development. It's a miracle these companies ever make a profit.
And in fact, these hardships mean few companies survive. As the number of suppliers falls, the survivors can raise their prices sharply. When you're the only company left standing, and telecom companies need your new widget to make their networks run smoothly, you can command almost any price.
The rig business booms when oil prices soar. And the telecom-equipment business booms when demand for bandwidth grows even more than is expected.
Demand for bandwidth is determined by its availability (its price), processor speeds, the number of users, and the amount of data storage available.
Bandwidth usage has been increasing 50% per year since 2002, a pace that doubles the total amount of bandwidth in the system every 1.4 years. This growth is "normal." It's a function of falling bandwidth prices, growth in the size of the network, and new applications, like YouTube, which are increasing the amount of video available.
But I believe the demand for bandwidth is going to grow a lot faster than expected over the next several years...
First, at the end of last year, IBM scientists pioneered a "significant milestone" in using optical signals on a chip instead of electronic signals. IBM says that within five years, this new technology will lead to smaller, faster, and more energy-efficient computer processors.
Second, while only 20% of the world's population uses the Internet today, the total number of users continues to grow rapidly.
Third, Verizon has already converted more than one million customers from high-speed DSL or cable modems to fiber-optic connections, which use 10 to 20 times as much bandwidth as regular broadband links. AT&T has converted 250,000 customers. Qwest's fiber penetration rate is expected to grow from 23% to 40% through 2011.
The network is running faster, transporting far more data to far more users. The increases are getting bigger and faster at the same time. Meanwhile, there's been a lack of investment in global telecom infrastructure for the last five years. Nemertes, a research firm, recently predicted the Internet could begin to suffer interruptions, or "brownouts," as early as 2010 without significant upgrades, which is why a new building boom is already starting.
All the signs underscore what we already know: The demand for bandwidth will eventually outstrip the existing supply. Given all this, I think it's time to take a reasonable gamble on the best makers of telecom equipment.
Good investing,
Porter Stansberry
Editor's note: Porter Stansberry is a regular contributor to DailyWealth, a free investment newsletter focused on the world's best contrarian opportunities. We write with a simple belief in mind: You don't have to take big risks to make big money with your investments.
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