Highest-Flyer: Technology's Best in Class
BOSTON (TheStreet) -- As it almost requires a doctorate from MIT to understand some products, technology investing has become challenging. Cutting-edge technology is difficult for non-experts to comprehend. Investors are tasked with not only understanding a technology, but determining if it is relevant and which companies' versions will be embraced. Warren Buffett, famous for sticking to his "circle of competence", avoids technology stocks. But, in doing so, he has missed out on many of the best opportunities of his career.
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One thing is certain: Those who are able to identify successful tech companies when they're in a growth phase reap fortunes. In finding best-in-class tech companies, past performance is a relevant indicator.
One company still worthy of consideration, despite delivering a 2010 stock return of 274%, is chipmaker
Entropic Communications
(ENTR) - Get Report
.
Entropic designs, makes and sells systems for connected home entertainment. In other words, they build the chips and circuits that synchronize cable set-top boxes, high-speed broadband routers, digital video recorders (DVRs) and satellite outdoor units. Entropic sells its products to telecom carriers and cable-service operators. They are designed to enhance the quality and delivery of high-definition video and other multimedia content. Based in San Diego, Calif., Entropic was incorporated in 2001 and went public in 2007. Its stock has delivered annualized gains of 17% since then. It has rallied 25% in three months. Trailing four-quarter sales surged 58%.
Entropic lists the analog-to-digital conversion as a major growth driver. It also cites the trend for integrated PC, cable and phone service as a long-term catalyst for sales. Although understanding the details of Entropic's products and its sustainable competitive advantages is difficult, one can't refute Entropic's momentum.
In the third quarter, sales nearly doubled year-over-year to $61 million and soared 51% sequentially. Entropic swung to a quarterly net profit of $11 million, or 15 cents a share, from a loss of $1.2 million, or two cents, a year earlier. The gross margin inched up from 54% to 55%. The operating margin climbed out of negative territory and passed 18%.
Like many chip peers, Entropic finances with equity. Its balance sheet held $54 million of cash, equaling a quick ratio of 3.6, and no debt at quarter's end. Return on assets and return on equity, measures of profitability, rose from the negatives to 14% and 18%, respectively. Return on equity missed the industry average of 26%, but beat the
S&P 500
average of 13%.
With a market capitalization of $987 million and a forward earnings multiple of 15, Entropic is still a reasonably priced, under-the-radar stock. But, based on other metrics, including a cash flow multiple of 45, Entropic is now quite expensive.
MoCA, or multimedia over coaxial cable, is the technology supported by Entropic and its service-provider customers, which include
Verizon
(VZ) - Get Report
,
Comcast
(CMCSA) - Get Report
and
DirecTV
(DTV)
, and OEM, or original equipment manufacturers, which include
Cisco
(CSCO) - Get Report
and
NetGear
(NTGR) - Get Report
.
What's stopping other companies from poaching clients or product designs? Entropic holds 71 patents, with 185 pending. Entropic also has product breadth and is, indisputably, positioned at the forefront of an expanding tech synchronization market.
Barclays
, ranked as the top equity researcher by
Institutional Investor
, is optimistic about Entropic, rating it "overweight" with a $14 target, equivalent to 19 times its 2011 earnings forecast. The target suggests that Entropic still has 25% upside in 12 months. (Of note: Barclays is typically conservative with its targets.)
Broadcom
(BRCM)
, another top chip stock, poses a competitive threat and could steal market share. Still, the outlook remains positive, given MoCA's growth prospects and Entropic's reasonable valuation. Channel checks indicate that multi-room DVR offerings are seeing strong demand at cable companies, aiding the bull case for Entropic.
TheStreet's
quantitative stock model, which takes a cautious approach to equity research, upgraded Entropic to "buy" on Dec. 7 on technical and fundamental strength. The stock has pulled back from a 52-week high reached just yesterday. It ended up falling more than 5% from an intraday peak. Still, it's a stock to follow on any correction.
As far as stock performance is an indicator of business success, Entropic is certainly best-in-class tech. It has performed well since its IPO in 2007, a challenging year for fledgling small-caps, and would be an outstanding acquisition for a larger semiconductor company.
-- Written by Jake Lynch in Boston.
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