No group of stocks is more prominently represented in the under-$10 universe than former highflying software companies that are now languishing in the single digits.
We believe it is best to avoid the low-priced software stocks that have already experienced their best years of growth, and look for the off-the-beaten-path names. To help readers sort through this morass and find potential winners, we ran a screen for low-priced software plays that are expected to deliver double-digit earnings growth in 2006. Here are our top three picks, in no particular order.
, a stock we already own in the Stocks Under $10 model portfolio. Tibco's integration software can forecast consumer behavior accurately, making its useful in a service-oriented industry. We consider the stock a Game Breaker in our three-group rating system -- a Game Breaker is a company that is revolutionizing the way business is done.
Tibco was a solid performer in 2004, its shares gaining 97%. But weak sales in Europe and some sales execution problems getting deals done by the end of the quarter in the U.S. have led to two earnings shortfalls in 2005. But despite these disappointing operating results, the company has managed to deliver 25% year-over-year revenue growth in each of the first two quarters of 2005. That's because its products are consistently ranked by customers to be best in class, and its next-generation predictive software programs are just now starting to gain traction with customers.
Tibco has about $500 million in cash on its balance sheet, and earnings expectations from both the company and analysts have been reduced, which should allow for some nice upside earnings gains and sales upside surprises in the coming months if Tibco can improve its sales execution and if demand increases from European customers. We believe this is a strong possibility, given the company's excellent track record of sales execution in 2004 and a committed management team that has been straightforward with investors regarding the need to improve. We believe this stock has double-digit percentage upside potential from the current quote over the next year.
Our next pick is another integration software company
( WEBM). We rank webMethods as a Stealth Stock, because it flies under the radar of most investors and analysts.
The company's earnings are forecast by analysts to grow at a double-digit clip in 2006, but the stock trades at an enterprise-value-to-sales valuation of only about 1.25. With other players in the integration space such as
and Tibco trading at two or more times enterprise value to sales, the more value-focused investor will find a lot to like in webMethods.
Because the company's earnings growth assumptions are based more on expanding operating margins than on top-line growth, the key for webMethods achieving above-average returns for investors in the coming three to 12 months will be management's ability to rein in costs. Management has been successful so far in this regards, and it plans on lowering travel budgets and employee bonuses in order to improve margins further. Its June quarter sales of $47.7 million were about $500,000 shy of the consensus estimate, but the company managed to deliver a penny upside on the bottom line.
webMethods' shares would have as much as 25% upside from the current quote if they were to trade more in line with their peers. But we don't own the stock, because we prefer to play the growth aspect of integration software with Tibco.
Lastly, we believe enterprise resource planning software play
( LWSN) is on the verge of a turnaround, which would warrant an Inflection Point Play ranking. (We rank a stock as an Inflection Point when the company is nearing an important turning point that will drive investor optimism -- and shares -- higher.) The company has struggled with competition from larger competitors and experienced problems hitting the Street's sales and earnings estimates over the past few years, and its shares are 65% lower. But we believe Lawson's double-digit percentage upside potential from the current quote of $6.22 makes it one of the more attractive under-$10 software plays.
(Most Inflection Point plays, such as
( EP), which we sold earlier this year closer to $13 a share for a 35% gain, require patience and a lot of homework.)
Lawson's enterprise resource planning software, or ERP, enables data from different departments within a company to be streamlined and accessible for analysis. At the end of 2004, Lawson made a large acquisition of enterprise software play Intentia International. The deal is expected to close by the end of 2006, and Intentia's addition gives Lawson a more competitive product suite.
Even without the Intentia deal, the company's operating results have been improving. In its fiscal first quarter ended in June, the company earned 6 cents a share, topping analysts' forecasts by a few pennies. And its balance sheet remains solid, with about 40% of the company's current $569 million market cap made up of cash on the balance sheet.
Also, the company is adding to its sales force, a sign that demand is picking up and that the company has better visibility into a stronger product cycle. The added costs associated with the pickup in hiring will be offset, at least partially, by cost savings from the Intentia deal.
Lastly, the company could make for an interesting acquisition target. Competitors SAP and
are always on the lookout for software plays with improving fundamentals. Lawson's strong balance sheet -- the company has $234 million in cash and virtually no debt -- and low relative valuation at just over 1 times sales could pique some interest among its larger brethren.
William Gabrielski is a research associate at TheStreet.com and is accredited with a Series 7 license. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Gabrielski welcomes your feedback;
to send him an email.