Let me present 3 steps to making an investment decision:

  1. Make an observation
  2. Determine who will profit based on (1)
  3. Determine how YOU can profit based on (2)

Let’s see an example.

The MIT Media Lab has spawned a non-profit organization “One Laptop Per Child” which will begin distributing $100 laptops to students all around the world by early 2007.

Who Will Profit:
A quick read of the WikiPedia entry for the $100 laptop1 reveals that Advanced Micro Devices (AMD) will be providing the CPUs for these laptops. I don’t know what the markup will be on the 500MHZ CPUs AMD will provide for the laptops, but even if AMD only breaks even on the deal there will still be millions and millions of students using these machines. That’s great exposure for the company. Think: AMD inside.

How Can We Profit:
Buy AMD stock. (Simple huh?) You shouldn’t be buying a stock based on one news headline. But if you look into AMD, I think you’ll see that it is a strong company and has a good outlook. The company has been steadily taking market share from Intel (INTC) [2]. Meanwhile, we have begun to see an increase in computer sales as we enter the next big “refresh cycle”, with businesses replacing their aging systems [3]. A GROWING chunk of a GROWING market = profits!

AMD has a P/E of (gasp) 385 vs. Intel’s 20. Don’t be scared though. Yahoo! Finance calculates a more acceptable “forward” P/E of 32.79 vs. Intel’s forward P/E of 16.57. (Cyclical stocks will have hard to decipher P/E’s like this. Read this Fool’s article on P/E4 for more info.) Anyway you cut the math though, AMD near its 52-week high is trading at a premium to its peers. But the stock appears to be fairly valued when you factor in AMD’s higher potential for growth over the next few years (whereas Intel it seems can only go down from its current spot as the industry leader). Factor in the impact mass distribution of the $100 laptop will have, and I say the stock is much higher this time next year.

The 3 steps above seem simple enough, but the decisions made will vary highly based on the quality of data going in. It should be clear that to make BETTER investment decisions one needs to either make BETTER observations or be MORE ACCURATE in determining who will profit (and by how much). This is where Chris’ Tuesday post on The Importance of Buying What You Know is so important. Being knowledgeable and up-to-date on an industry, sector, or company will mean your observations will be more meaningful. That means you’ll make better investments. That means you’ll make more money.

Never stop learning; we don’t know everything. But we do know tech better than your average investor. So if someone tells you that you can’t have more than 20% of your portfolio in “internet” or “tech” stocks, don’t listen to them. As one fellow geek to another, I give you the permission to have as much as 40% of your investments in internet stocks as long as you are comfortable in your understanding of business and social culture that affects that industry. Beware of an industry-wide downturn. But if you are as geeky as I think you are, you should be able to detect such a thing before it occurs and shift your investments accordingly.

[1] $100 Laptop at WikiPedia
[2] AMD Grabs Intel Market Share in Desktop Arena by Tony Smith
[3] How to Use the P/E by Philip Durell
[4] Research Cycle Drives Market as Builders Broaden Offerings by Alexander Wolfe

Full disclosure: Jason owns a small number of AMD shares.