Amid a skittish market that swings wildly depending on the latest lurid news headline, one sector has maintained steady momentum that should continue into 2016: technology. Among the best tech opportunities next year will be Machine-to-Machine (M2M) communications and new ways to leverage the cloud.
Below are the two purest stock plays on each of these megatrends. With exponentially expanding markets but small- to mid-cap valuations, they also confer more room for growth than their large-cap brethren in the tech sector.
Investors are fretting over a slew of potential woes, not least of which are war and terrorism overseas, but through it all the tech sector has been on a steady roll. The Technology Select Sector Index (XLK) is up 4.6% year to date, compared to nearly zero gain for the S&P 500.
Tech leaders such as Apple, Microsoft, and Alphabet recently released robust earnings, and their stocks have risen accordingly, but there's more to the tech sector than familiar brand names.
Two exciting but underappreciated cases in point: Digi International (DGII) in the M2M segment and ServiceNow (NOW) in cloud computing. These two tech stocks are on the verge of breaking out, but they don't get the same fulsome press coverage as the entrenched giants.
Let's take a closer look at these under-the-radar companies, each of which is well positioned for outsized gains, despite today's market volatility.
1. Digi International
The personal computer, the cell phone and the Internet revolutionized the way we live and do business. We're now on the cusp of another paradigm shift: Machine-to-Machine technology.
Founded in 1985, Digi is the pioneer in the creation of M2M devices and platform solutions. Digi also provides the most sophisticated line of cellular gateways specifically designed for M2M applications. With a market cap of only $315.31 million, the company has enormous room for long-term growth.
M2M devices communicate with each other through a central server, without a human being as intermediary. They use sensors to transmit valuable data -- such as fuel levels, room temperatures or inventory capacities -- through a wired or wireless network to a software application.
The software application translates the data for meaningful action. For example, if the data exchange indicates that a refrigerated locker is getting too warm, the system will make a temperature adjustment automatically and without a person getting involved.
M2M remotely connects a wide variety of machines into a complex communications matrix. Major applications today include utility meters, fuel tanks, vehicle fleets, point-of-sale scanners, and medical instruments in a hospital. M2M also automates the delivery of services and billing, making them more efficient and cost effective.
Under conventional technology, a remote network of machines sends data to a centralized hub for human analysis and action. M2M not only eliminates the flesh-and-blood middleman; it also fosters an integrated web of networks that can communicate with smartphones and other mobile devices. M2M networks dramatically reduce the cost, time and energy required for data transfer, opening new opportunities for businesses -- and investors.
By using the company's products, businesses or government agencies can connect electronic devices from any remote location via a public online connection, Virtual Private Network (VPN), the cloud, satellite network or cellular carrier.
Digi has emphasized M2M since the company's inception, a focus that has given it technological dominance and a jump on future competitors. This company will be among a group of technology all-stars that are poised to reward investors in 2016.
Last month, Digi reported fiscal fourth-quarter revenue of $56.4 million, compared with $51.6 million for the same quarter a year earlier. Earnings came in at $3 million, or 12 cents per share (EPS), compared with EPS of 2 cents in the same quarter a year earlier.
For the full fical year, total revenue grew 10.5% to a new annual record of $212.9 million, from $192.7 million last fiscal year. Full-year earnings came in at $6.6 million, or EPS of 26 cents, compared with earnings of $1.8 million or EPS of 7 cents in the previous fiscal year.
For the full fiscal year 2016, Digi management projects revenue in a range of $209 million to $223 million, for a year-over-year increase of 3% to 10%. Digi projects EPS in a range of 28 cents to 44 cents.
Small wonder the stock has risen nearly 36% year to date and 74% over the past year. Yet its trailing-12-month price-to-earnings ratio stands at 48, compared with 49 for its industry, making Digi shares a good price for their growth prospects.
The transition to "the cloud" is among the biggest tech trends afoot today. By using data storage and IT capabilities that are centralized and located off-site, companies are able to greatly reduce their processing costs through efficient outsourcing. It's a disruptive technology that has been a game changer in the fast-moving tech sector.
A leading player in cloud computing is ServiceNow. Although it's been around only since 2003, the company already has a market cap of $13.4 billion. Through innovations in cloud technology and aggressive courting of new customers, ServiceNow has been stealing market share from IT legacy system companies such as IBM, a trend that shows no sign of abating.
The greatest strength of this tech up-and-comer: It generates revenue from subscriptions, a business model that should drive top-line growth as the company expands.
ServiceNow's Platform-as-a-Service (PaaS) subscription model is an IT delivery method whereby software and related data are centrally hosted on the cloud and accessed by a Web browser. PaaS has become all the rage for many widely used business apps.
ServiceNow recently launched HR Service Automation, an application that automates human resources data. The company also recently bought Mirror42 Holding BV, a cloud-based performance analytics company.
ServiceNow's third-quarter revenue and EPS beat analyst expectations. Revenue of $261.2 million grew by 46% on a year-over-year basis and was ahead of the average analyst estimate of $256.2 million. Adjusted earnings per share were 15 cents, ahead of the consensus for 8 cents.
The company's total billings reached $286.4 million, a year-over-year increase of more than 38%.
The stock is up 25% year to date and has risen 30% over the past year, but there's plenty of room for future appreciation. Although it has grown rapidly, ServiceNow only accounts for a small sliver of an industry that currently generates about $45 billion a year in sales.
Management expects the company to post $4 billion in sales in 2020, making this stock a solid long-term growth play on an unstoppable technology trend.
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