Early Investing

Choose Startups for Tech Exposure

Choose Startups for Tech Exposure
By Adam Sharp
Date March 26, 2021

Tech stocks are getting eye-wateringly expensive. Here are a few examples using their price-to-earnings (P/E) ratio.

  • Tesla: 997x
  • Square: 490x
  • Netflix: 83x
  • Amazon: 73x
  • Zoom: 140x

These are all very well-run companies which probably have bright futures ahead of them. But their shares are priced for perfection — as if another 20 years of amazing growth is guaranteed. 

And those are just the profitable examples. There are plenty of high-flying tech stocks from companies that are still losing huge amounts of money. Off the top of my head, there’s Uber, Snowflake, Twitter and Snapchat.

Overall, the Nasdaq 100 index trades at a 37x P/E ratio today. That’s quite high. And we can’t really use COVID-19 as an excuse because the shutdowns have actually been good for most tech stocks.

In my view, these are great companies — but not great stocks to buy. History is littered with noteworthy examples of similar situations that serve as warnings for us today.

Let’s take a look at Cisco in 1999. Cisco servers were powering the internet. The company’s revenue (and shares) had gone practically straight up for a decade. It seemed absolutely unstoppable.

Cisco shares peaked in 1999 at a share price of around $77. The P/E ratio was 110x, while the price/sales ratio was an impressive 19x. It was a great company at a really stupid price. Since then, Cisco has never managed to reach that 1999 high again. Today it trades around $51.

Startups > Tech Stocks

I believe we’re nearing 2000-levels of exuberance in tech stocks. Prices will have to come back down to more normal levels at some point — and I suspect we’re not more than a few years away from that happening. I may be wrong, and the bull market may continue for another decade. But it seems unlikely based on history.

Either way, I simply can’t bring myself to buy tech stocks at these levels. But I obviously still want exposure to technology. So I’m getting it through private startups.

In order to have a good chance at success in startup investing, you need to build a substantially large portfolio. In the majority of startup portfolios, most of the gains will come from the top one or two performers. So you need a large basket of opportunities in order to have a good chance at hitting something really big. I’ve made small investments in more than 100 startups since 2014. And I plan to keep adding 10-to-15 more per year. 

Fortunately proper diversification is doable for many investors today, as the minimum investments on most equity crowdfunding deals is around $100.

Beyond diversification, my general advice to new startup investors is pretty simple:

  • Start slow. You’ll get better over time.
  • Try to mostly pick companies with solid traction (revenue).
  • Don’t invest in a startup just because you love the industry.
  • Pick founders who are charismatic and good communicators.
  • Don’t invest more than 5%-to-10% of your portfolio in startups.
  • Patience is key. It often takes around 10 years for a great exit to happen.

Now is a great time to begin startup investing because the SEC recently bumped the fundraising limit for companies to $5 million. We’re going to see a flood of more mature startups with great traction coming to market over the coming months.

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