News Analysis date published New: 
Friday, May 13, 2011 - 13:00
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Friday, May 13, 2011 - 13:00
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Friday, May 13, 2011 - 13:00

3 Tech Stocks with More than 25% Upside

Friday, May 13, 2011 - 1:00pm

Investing in tech stocks can be quite tricky. The biggest players such as Microsoft (Nasdaq: MSFT), Dell (Nasdaq: DELL), Cisco Systems (Nasdaq: CSCO) and Hewlettt-Packard (NYSE: HPQ) are struggling to find growth. The industry's smallest players can post impressive growth in short stretches, but they can also plunge in value if growth cools. Shares of mobile data service company Motricity (Nasdaq: MOTR), for example, which I wrote about here, raced from $6 to $30 and back to $10 in less than a year.

That's why I like mid-cap tech stocks. They often have solid growth prospects, while their recurring revenue streams reduce the chances of a quarterly blowup. They're not fast-moving stocks, but they tend to be steady gainers over extended periods.

I went looking for these mid-cap plays, which I'm loosely defining as having market values between $500 million and $5 billion. I wanted to focus on GARP (growth at a reasonable price) stocks, so I searched for stocks with price-to-earnings (P/E) ratios that are lower than their earnings-growth rates -- also known as PEG stocks (or stocks that have a P/E below the earnings-per-share (EPS) growth rate).

Here's what I found...

The following companies caught my eye...

1. Cypress Semiconductor (NYSE: CY)
I'm usually hesitant to recommend stocks after they have had a strong run, but Cypress Semiconductor looks to have plenty more upside in the next year. Cypress is a diversified technology play, making everything from specialized memory chips (SRAM) to USB drive controllers to touch-screen devices. Due to a host of factors, each of its product lines is seeing rising demand. And a current heavy slate of research and development initiatives could lead to a cycle of new products that are expected to be available to customers later this year and in 2012.

The SRAM business recently got a real break. Japan's Renesas Electronics Corp., a leading SRAM supplier, is having manufacturing problems because of the earthquake and tsunami that hit the country in March, so a number of customers have turned to Cypress to fill in the output gap. Management had thought this would be a very low-growth business in 2011, but the coming quarters could see newfound momentum as Cypress takes a bigger chunk of the SRAM market share.

The touch-screen business has never gotten the full credit it deserves, largely because the company failed to woo Apple (Nasdaq: AAPL), which largely pioneered the touch-screen business with its iPhone and iPad. Yet Cypress still works with a wide range of other companies and recently secured new deals that could help turn its touch-screen efforts into a $200-million business this year. Those customers include:

  • Garmin (Nasdaq: GRMN) and TomTom in GPS devices
  • Hewlett-Packard in printers
  • Cisco Systems in IP phones
  • Sony (NYSE: SNE) in cameras
  • BMW in car-based systems

The company's USB business is also poised for a nice lift. The entire computer industry is about to upgrade from USB 2.0 to USB 3.0, enabling consumers to have more storage capacity and faster download capability on those handy little thumb drives. Data between printers and computers will also be much faster. Cypress is likely to see the benefits of the transition late in 2011.

All of these drivers are fueling a solid profit picture for the company. Per-share earnings are expected to rise from less than $1 in 2010 to around $1.25 this year and to $1.50 by 2012. Analysts at Needham and Sterne Agee say the consensus forecast is too conservative, predicting 2012 EPS of $1.70 and $1.80 respectively. Shares trade for just 12 times Sterne Agee's street-high view.

To support shares while they still sport a reasonable multiple, management has been buying back stock and has another $300 million left to go. If shares trade up to 16 times Stern Agee's 2012 profit outlook, then they would rise from a current $22 to $28. That's more than 25% upside, perhaps not the kind of stark upside that aggressive growth investors may crave, but quite respectable when you look at the growth rates and upside of some of the bigger tech players.

2. ON Semiconductor Corp. (Nasdaq: ONNN)

I wrote about ON Semiconductor about a month ago and upon deeper reflection, the company looks more appealing than I first thought.

ON's first-quarter results were well ahead of forecasts. The chip maker has been moving quickly to integrate the acquisition of a large division of Japan's Sanyo. Synergies with Sanyo instantly boosted the sales base by 50%, and management's 12–18-month goal of bringing profit margins up at the acquired business now looks highly achievable. In fact, that process may complete by later this year, according to analysts at D.A. Davidson. Firming margins translate into higher EPS forecasts. Davidson now sees EPS in 2011 and 2012 about $0.15 higher than before, or $1.17 and $1.33, respectively. Shares, trading at less than nine times the 2012 outlook, look quite appealing.

3. GT Solar International Inc. (Nasdaq: SOLR)
As I mentioned earlier this week, being one of the main suppliers of clean-energy technology to solar-panel makers means GT Solar is a very stable business,. And like ON, this company looks much more appealing than I previously thought.

Investors should expect positive management commentary when the firm reports results in about two weeks. GT Solar recently announced nearly $100 million in new orders for its cutting-edge, high-margin Sapphire Furnace technology. This is likely to pump up an already strong backlog.

It's not clear yet whether investors are responding to the company's very low P/E ratio, the rising backlog or its prodigious free cash flow, but shares are now moving up to their highest levels since January. Still, they sport the lowest P/E ratio of any stock shown in the table above.

Action to Take --> These tech stocks offer the best of both worlds: reasonable downside protection afforded by low P/E ratios and potentially solid upside, thanks to projected earnings momentum. Investors looking for a good combination of safety and upside would do well to consider these stocks.

P.S. If you're an income investor, why would you buy a stock yielding 2% when you can find one paying 26% right here? Watch this presentation for more.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.