When looking for growth investment opportunities, technology companies are generally a good place to start. The problem is that not all technology companies are created equal. Investors must be wary of overly exuberant valuations and weak fundamentals. I have chosen five technology companies from different industries to see if any will make good growth additions to our portfolio in the future. Specifically, these names have price to earnings ratios below their industry averages and forward earnings growth above the industry average. Despite these positive metrics, some of these growth names may fall short of expectations. First I analyze the two that fall short, and then I identify the three stocks from which value investors can profit.
STEC, Inc. (STEC)
Second quarter earnings for solid-state drive maker STEC were not pretty this year. The company missed analyst expectations by a penny and offered guidance for the third quarter about $0.20 lower than analysts were expecting. Not surprisingly, the stock was hit hard-- falling from $17 to $9.75 in one day. As big a drop as that is, if earnings come in as low as guidance, the stock is still probably overvalued. Currently shares trade for 20.1 times forward earnings and offer no dividend. This is in line with competitors NetApp Inc. (NTAP) and EMC Corp. (EMC), which trade for 20.7 and 20.0 times forward earnings, respectively. However this is much more expensive than the industry leader SanDisk Corp. (SNDK), which trades for 12.1 times forward earnings.
While it would be surprising if earnings for STEC actually come in as low as current guidance, if they do, expect another major decline in STEC’s share price. Earnings gambles aren’t generally a value investor’s idea of a good investment, so it’s probably best to avoid STEC until it proves to have a more positive outlook.
Synaptics Inc. (SYNA)
Shares for human interface developer Synaptics are flying high after great third quarter earnings that beat analyst expectations by ten cents. Share prices responded accordingly and jumped from $26.96 to $32.88 by the next day. Shares now trade for 20.1 times forward earnings. This isn’t too bad considering some of the others in the computer peripherals industry-- Aruba Networks Inc. (ARUN) and Fortinet Inc. (FTNT) trade for 131.5 and 62.3 times forward earnings respectively. That said, value investors generally are looking for better deals than 20 times forward earnings. Synaptics fundamentals are improving and the company’s outlook is promising. In any case, value investors should wait for a pullback before buying.
Trina Solar Limited (TSL)
The solar industry has become a tough place to be over the last six months. Germany has announced subsidy reductions, while at the same time many solar panel manufacturers have been ramping up production. As economics predicts, this oversupply has been met with a collapse in the price of solar panels. Shrinking margins and weak demand caused by the elimination of subsidies has hit companies in the solar industry hard. Trina Solar has missed analyst estimates for two quarters and the company’s share price fell from over $26, down to as low as $5. Shares have since rebounded to just under $10, which is still just 6.9 times forward earnings. Other solar manufacturers are trading for similar multiples-- 7.7 times forward earnings for First Solar, Inc. (FSLR) and 6.1 times for Yingli Green Energy Holding Co. Ltd. (YGE). These are very attractive valuations for companies that just last year were flying high. It’s reasonable to believe this rough patch in the solar industry is temporary.
Many things affect the demand for alternative energy: subsidies, oil prices, the economy, people’s opinion of global warming and the market supply of solar panels. While these factors are all difficult to predict, most commodities with multiple unknowns tend to produce a cyclical pattern of prices. At some point, demand for solar will catch up with supply. Investors obviously should be concerned with how long this will take, however value investors can be patient and wait knowing that a rebound in the solar industry is inevitable. Examine these solar manufacturers closely, because in the long run, the market for solar panels will expand and that expansion will allow for some winning companies. For value investors these valuations are about as good as it gets for an industry with this kind of growth potential. Look closely at the solar companies because these low valuations may not last long.
Tyler Technologies, Inc. (TYL)
Investors are high on software solutions provider Tyler Technologies. The company is based out of Texas, and offers information management solutions and services to local governments throughout the United States, Canada, the Caribbean and the United Kingdom. A solid earnings report for the third quarter of this year provided the company with a large jump to its share price. Now trading for 39.8 times forward earnings, value investors should be aware that expectations might be a little overzealous. More established names in the industry trade for almost half that-- 26.0 times forward earnings for Autodesk Inc. (ADSK), 25.0 times for MICROS Systems Inc. (MCRS), and 20.0 times for Infosys Ltd. (INFY). That said, Tyler Technologies has managed to grow its earnings at 29.3% a year over the last five years. That kind of growth makes the 39.8 times valuation a little more understandable.
The company makes half of its revenue from maintenance, a stable form of income. Also, the majority of the company’s clients are local governments, which are generally stable customers. The company’s long-term stock chart looks great and the company has a nice niche to operate in. Value investors might want to splurge on this high valuation because the company’s prospects are so strong.
Xilinx Inc. (XLNX)
Despite solid earnings, it has been a bumpy road lately for Xilinx investors. The company makes integrated circuits that can be used in a whole host of applications. Shares are trading for 17.8 times forward earnings which is inline with others in the industry-- Altera Corp. (ALTR) and Lattice Semiconductor Corporation (LSCC) trade for 16.8 and 16.2 times forward earnings respectively. The plus with Xilinx is the 2.3% dividend yield, which is rare in the technology world. Furthermore, Xilinx has managed to grow earnings 19.1% annually over the last five years while the industry average is a 2.5% annual decline.
The company has strong a competitive advantages and should be able to maintain this growth. The second quarter of this year marked the end of Xilinx’s fiscal year. The company’s earnings for fiscal year 2011 came in at $2.39, much higher than 2010’s $1.29 earnings per share. The valuation is a little high for some value investors, however the company’s growth history and dividend yield might make it more attractive. Value investors should take a closer look.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.