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Before investing in technology stocks, learn lessons from the last bubble

Initial public offerings. Big takeovers. Nerdy 20-somethings getting rich quickly. To borrow a phrase from an old Prince song, the markets are suddenly partying like it's 1999 again.

The tech bubble is back. The trouble is, everyone still remembers how the bubble burst last time around. Investors know there is a lot of money to be made from technology. They also know there is just as much to be lost when the bubble bursts.

Facebook is valued at $50 billion, on the basis of its most recent stock sales. Groupon, the Chicago-based daily-deals site, has held talks about an IPO that would value it at as much as $25 billion, according to people familiar with the matter. Twitter valued itself at $3.7 billion at the end of last year and may be worth a lot more by now.

Not everyone thinks it will end happily.

"Most of them will be overpriced," said Warren Buffett, chairman and chief executive officer of Berkshire Hathaway, speaking about social-networking valuations last month.

However, the likes of Google, Amazon.com and Apple are now among the world's biggest companies. The Internet economy is expanding all the time. If you invested in the right firms last time, you made a lot of money.

So the trick is to back the right horses — and to do that, you need to learn the lessons of the last tech bubble to steer your way through this one.

First, don't worry about business models. Google didn't have one to start with. Neither did Facebook. The advertising came later. Both concentrated on making a great product that would have a huge audience and hoped that the revenue would follow. So don't fret about how the business doesn't make any money yet. As long as the audience is there, it will be fine.

Second, look for monopolies. The Internet often creates companies with massive market share. There is a simple reason for that: the network effect. We all use Microsoft operating systems because everyone else does. Likewise, we go to Facebook because that is where all of our friends are. So it's best to look for sites or software systems that everyone flocks to — not because they are necessarily that great but just because everyone else does.

Third, skip the companies selling shares too soon. The best Internet entrepreneurs are greedy. They know they are on to something good, and they won't be giving away equity until they have to. Watch for the businesses where the founders are selling stock only when they really need to — and skip the ones that are cashing out too early.

Fourth, buy after the IPO. There is an inevitable cycle of hype and disappointment before the really strong businesses emerge. The company goes public on a wave of excitement. Then there is disappointing news, and the shares crash. Make sure you buy on the disappointment rather than the hype.

Before investing in technology stocks, learn lessons from the last bubble 04/05/11 [Last modified: Tuesday, April 5, 2011 9:38pm]

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