The Three New Rules for Tech-Stock Investing

Tech stocks are dead. Long live technology investing.

The three great rules for finding a highly profitable technology stock still work as well as they did back in the days when Microsoft(MSFT Quote), Intel(INTC Quote), Dell(DELL Quote) and Cisco Systems(CSCO Quote) were the kind of stocks that set an investor's blood racing and produced lip-smacking profits for portfolios.

I just don't think the rules work very well for mainstream technology stocks anymore.

That's because, first, the technology sector has changed so radically since the good ol' days before the bear market that began in March 2000. And second, because changes in the energy sector -- yes, the energy sector -- have created stocks in that part of the market that show all the traits of technology stocks in the 1990s.

Sales, Apps and Margins

What are the three great rules of technology investing?

1. Look for the hockey stick. This has nothing to do with sports. Instead, the "hockey stick" describes a highly desirable pattern in a company's sales growth. Initially, sales start off at a low level and grow slowly over time, sketching in the blade of the hockey stick.

Then, if all goes well, at some point sales start to increase more rapidly, creating the upward curve that is the stick's neck. And then, if this technology company is really on to something, sales take off and growth becomes almost vertical. That's the handle of the stick.

Do I need to say that you'd like to own a stock when the company's sales -- and earnings -- growth goes vertical?

2. Look for the killer app. The killer application -- the software program, piece of hardware, product improvement or whatever -- that everyone has to have is what powers hockey-stick growth. It took everyone a while to figure out what an Internet browser was and what it was good for, but once that period of slowly growing use was past, everybody had to have one, because being browserless was just inconceivable. Same with digital cameras and wireless phones and, before that, with routers and personal computers themselves.

3. Look for a company with sustainable high margins. In the technology markets of the 1990s, a company could ride a sustainable proprietary edge -- and a willingness to use that temporary advantage over the competition as if the devil were at its heels -- to years and years of outsized profit margins.