Jim Pearce is Investing Daily’s Wealth Society director and a former investment advisor with 30 years of portfolio management experience. Leo Boeckl, a long-time tech industry strategist and insider, is the inventor of a proprietary valuation model for tech stocks that has worked with uncanny accuracy.  Please click here to hear them discuss the approach they take to evaluating tech stocks.

Introducing the BiQ

Last week we defined the term “innogration”, and how it explains why some tech companies thrive while others fall behind. To remind you, innogration is the combination of innovation and integration, which is the process of creating a superior product by using both internal and external resources to provide a market-leading product. Let us explain how we measure innogration, and why that can be valuable to you in determining which tech stocks to buy or avoid.

Since we believe that a company must possess three critical traits in order to successfully innograte, we have created a metric that measures each of them which we have dubbed the Boeckl Innogration Quotient, or “BiQ” (pronounced “Bick”). It consists of three components, which assign a numerical value to the extent a tech company possesses each of the following characteristics:

1. Pays a dividend sufficient to attract investor capital and stabilize its share price;
2. Grows operating cash flow at a rate sufficient to pay a dividend while investing in both internal and external resources for product development; and
3. Executes a business strategy that is based on convergence and has correctly targeted one or more end-point technologies as its primary product(s).

How we measure Innogration

The first and second components of the BiQ are relatively easy to quantify since they are completely objective and the data is readily available. However, the third component of the formula is entirely proprietary and to a certain extent the product of our subjective judgment. Over time we have developed a formula for assigning a numerical value for the strategic component based on the extent to which specific elements of strategy are being pursued.

The maximum BiQ a company can achieve is a 10, based on a maximum score of a 3 for dividends, a 3 for innogration, and a 4 for strategy. The minimum possible score is 0. Dividends are compared to current yields in the U.S. Treasury bond market, and cash flow from operations is evaluated based on the extent to which it is on a positive growth curve over the past three years. Combined, these two components measure the extent to which a company possesses the financial wherewithal to compete for investor capital while making the necessary investment in product development.

The BiQ is unique in that it is the only technology industry metric we know of that is truly predictive in nature. The market leading products of the future are not on the store shelves today. Instead, they explode onto the scene when the right set of technologies are combined and collide with consumer demand. So, instead of trying to guess exactly what those products will be, we believe it makes far more sense to identify the companies that will create them.

The Contested Categories

The strategy component of the BiQ is built around the notion of convergence that we alluded to earlier. Therefore, it is critically important to identify the “endpoints” of the current wave of technology convergence, as ultimately the category winners in each of those segments should also offer the greatest return on investment. Specifically, we believe there are five categories currently being contested in the battle of technology convergence: Smartphones, Mobility, Media Content, Personal Computers, and the Cloud.

It is difficult to overstate the extent to which the Smartphone has revolutionized personal computing. In 2012 orders for PCs declined for the first time ever, a trend that has accelerated in 2013. A recent study by the United Nations revealed that while only 80% of the world’s population has access to working toilets, 85% have access to a cell phone. While the Personal Computers will be around for a long time, especially for business use, the Smartphone has clearly supplanted PCs as the primary internet access point for most users.

As a result of continued growth in cell phones and tablets, along with the expected rise in even smaller devices such as watches and glasses, demand for cloud storage is expected to soar to provide the degree of memory and performance that will be expected. All of which will only further increase the need for enhanced Mobility so that the Media Content being provided can be accessed in whatever format is desired. The companies that recognize this and are able to implement effective strategies to capture a leading position in one or more of these categories are exactly who our BiQ methodology is designed to identify.

Next Issue: Converting BiQ Scores to Buy and Sell Recommendations

SPECIAL ALERT: Last night on “60 Minutes” Amazon CEO Jeff Bezos unveiled flying drones as the delivery mechanism of the future for his company, in his estimation beginning perhaps as soon as 4 – 5 years from now. These miniature missiles could handle packages weighing up to five pounds, which comprised over 80% of Amazon’s sales last year. Regardless of how accurate that prediction turns out to be, the fact that it is now being seriously discussed illustrates the extent to which technology is disrupting traditional methods of commerce, and will continue to in the years to come. However, as measured by our “BiQ” formula Amazon comes out slightly below average with a score of 4.2 since it pays no dividend and is only growing cash flow modestly (up 13% over the previous two years average) despite being clearly positioned as a long term category winner. Next week we’ll explain in more detail how we evaluate tech stocks like Amazon, and whether or not this high flying stock should be in your portfolio. Tune in!

View Part 2: Understanding “Innogration”

View Part 4: Converting BiQ Scores to Buy and Sell Recommendations