Ashraf Eassa Positions For 2014: Take Advantage Of Cyclicality In Technology

by: Ashraf Eassa

This is the 12th piece in Seeking Alpha's Positioning for 2014 series. This year we have once again asked experts on a range of different asset classes and investing strategies to offer their vision for the coming year and beyond. As always, the focus is on an overall approach to portfolio construction.

Ashraf Eassa is an investor and financial writer with Bachelor's degrees in Computer Science and Mathematics. He spends his days looking for compelling investment ideas, particularly in the technology sector, and strives to bring these ideas to his nearly 7300 followers on a daily basis. When he's not knee-deep in the markets, he can be found reading books on the latest-and-greatest hardware software technologies and whipping up applications for both the PC and ultra-mobile devices.

Seeking Alpha's Abby Carmel and Jonathan Liss recently spoke with Ashraf to discuss the big trends in technology investing in the coming year and beyond.

SA Editors (SA): How would you describe your investing philosophy, broadly speaking?

Ashraf Eassa (AE): I'd describe myself as a value investor with an eye towards technology. I know that's somewhat of a contradiction, particularly given that many successful technology investments tend to look like anything but value stocks, but understanding a situation and leveraging knowledge of technology and potential industry trend shifts can be very helpful in distinguishing between "values" and "value traps."

(SA): As we approach 2014, are you bullish or bearish?

(AE): That's a toughie. I think 2014 will be a stock picker's market. The market as a whole may not see as nice a run as we saw in 2013, but there will be ample opportunity to take advantage of individual names that could generate quite healthy returns - well in excess of what I believe the general market will bring.

(SA): What are the big trends or themes you are focusing on in your technology investing right now?

(AE): Right now, a theme that I particularly like is "consolidation" and how best to profit from it. We saw a lot of consolidation in the flash/SSD space over 2013, particularly as Seagate (NASDAQ:STX) and Western Digital (NYSE:WDC) really went on an acquisition spree. I think we'll see more consolidation across the broader technology spectrum, particularly in the semiconductors. Already this year two of my Top Ideas - LSI and Spreadtrum - were taken out at pretty hefty premiums. I expect to see much more of this next year.

Another idea I like is simply trying to take advantage of cyclicality in a number of tech areas. Mellanox (NASDAQ:MLNX), for example, seems set to rise pretty nicely as the HPC market sees a cyclical upturn. I'm also pretty interested in the sapphire plays - namely GT Advanced Technologies (GTAT) and Rubicon (NASDAQ:RBCN) - especially in light of what Apple (NASDAQ:AAPL) could be doing with sapphire. A broad industry shift to that material could mean very good things for both of those stocks - even after the deal Apple signed with GT.

(SA): How do you identify major trends ahead of the crowd by investing in companies that have the potential to become tomorrow's Intel (NASDAQ:INTC) or Apple?

(AE): To be perfectly fair, I don't think I've ever actually identified an opportunity that lucrative. That said, trying to identify the next "big thing" is about understanding not just the technology but the potential need. Why did smartphones succeed so brilliantly? It was because people needed the ability to access data and communicate in a way that had been previously restricted to the PC via a limited Ethernet or Wi-Fi connection.

An investor that can identify a technology that fundamentally makes people's/customer's (remember, there are game-changing technologies outside of the consumer space) life easier/better is an investor that's probably going to strike it rich.

(SA): How is stock picking in the technology sector different than in other sectors?

(AE): Investing in technology stocks is really about identifying broad trends, understanding product cycles, and being able to sort of "guess" what people will get excited about. Oftentimes the big runners in tech run not on "earnings" per se but the excitement over that particular opportunity.

On the long side, if you can identify a company that could eventually strike it rich on a very real opportunity, then getting in before the hype starts to kick in is usually a great way to make money. Watch out, though, because great short opportunities are made by people taking one "good" data-point and extrapolating it out to infinity. Be very careful to not confuse a cyclical top with the first innings of a true secular growth story.

(SA): Can you buy good technology companies at attractive prices today?

(AE): Yes, but it's tough. In this environment, value is concealed, so the focus needs to turn more on trying to find businesses near cyclical troughs as well as "special situations." Will the momentum names work? Maybe, but frankly, I'm much more interested in shorting momentum names with interesting catalysts than trying to play the game of hot potato.

(SA): You tend to concentrate on and invest in a small number of stocks - why?

(AE): Honestly, I think this is more due to limitations of time than anything else. When I make a transaction (long or short), I want to know that company's story inside and out. I want to know what investors are concerned about, what they're hopeful for, and want to be able to find ideas where the weighted average of the possible outcomes favors the position that I take.

I think spreading yourself too thinly and trying to understand a bunch of different sectors and individual stocks within those sectors really dilutes the quality of the research, the confidence in the position, as well as the returns (but of course, this is just what works for me - Stephen Simpson, a very prolific generalist who does very well in the markets, would likely disagree).

(SA): Tech companies have lately been undergoing a transition from growth-focused entities that generally plowed all additional cash into R&D to value-focused dividend payers. What does this say about the future growth prospects of the tech sector and is it ultimately bullish or bearish for stock prices?

(AE): It's my view that R&D is the lifeblood of any technology company. Now, I think that for larger, well established players operating in secular growth markets, there's less of a need to plow all of that excess cash into R&D. Eventually, particularly in tech, a company "tops out" and the value gained from each incremental R&D dollar may not be worth it.

So, if you're, say, Microsoft (NASDAQ:MSFT), then more buybacks and more dividends probably do better for shareholders than a massive spike in R&D, since at that point there's probably so much "dead weight" and R&D inefficiencies there that it just wouldn't be worth it.

A small cap tech company with a great idea and is growing like gangbusters, on the other hand, should be investing as much as it can to maintain its unique technological edge. While these companies can't all be the next Microsoft or Intel, they can certainly grow substantially (delivering many hundreds of percentage points of returns for investors) and/or end up being an attractive take-over target for giants.

(SA): Cloud computing continues to represent a significant opportunity for technology investors. How should investors capture the tremendous growth potential in cloud computing and software as a service?

(AE): Oh, cloud computing? Bet on hardware and infrastructure. There's a massive cloud build-out that benefits just about anybody that makes networking and server components. Names I like here are INTC, Broadcom (BRCM), MLNX, EZchip (EZCH), and Marvell (MRVL).

As far as SaaS, I tend to think that many of the names are simply in a bubble, so I'm avoiding it for the most part.

(SA): Would you advise buying tech ETFs?

(AE): If you don't have the time to do the detailed work on an industry and the various names in that particular industry, then ETFs are a great way to go. These allow investors to bet on broader industry trends without all of the stress of needing to pick the "best" plays within a sector.

That being said, if you can afford the time to do the work, individual stock investing can be much more rewarding than investing in ETFs.

(SA): What advice would you give to a 'do-it-yourself' tech investor looking at opportunities in the present environment?

(AE): Understand the sector you want to invest in and understand the "story" behind each company. I don't mean the party line you see at investor/analyst days, but I mean all of the ugly warts as well as the positives. Listen to conference calls, figure out what makes the company/stock tick and what events/catalysts could drive upside/downside.

In particular, when it comes to tech, look for companies that have "issues" that can eventually be resolved. For example, one of my more successful calls - Logitech (NASDAQ:LOGI) (which more than doubled from the initial call) - was a PC peripheral play that was suffering from intense competition, market-share loss due to negligence in a number of areas, and a complete misunderstanding of the pace of the growth industries it was trying to play in.

Once it was clear that these issues were solvable and once it was clear that management really understood those problems, it was the time to buy. Not all companies with "issues" are good buys, but if the management team is competent, the balance sheet is in decent shape, and the company itself is equipped enough to actually compete profitably, then there's a good bet that you can make some real money on them.

(SA): Any additional considerations you'd like to share with readers as they ponder their investing strategy in 2014 and beyond?

(AE): Do your research and always question claims that people make. Not just your peers in the comments sections, but professional analysts and even myself. Sometimes, there's real money to be made in identifying a fundamental misconception that the rest of the market eventually realizes. However, this is exceptionally tough and sometimes "obvious" folly on Wall Street's part isn't always as "obvious" as it seems.

Disclosure: Long: NVDA, BRCM, UTEK, INTC, PSMI, RFMD, IGNMF. Short: AMBA

To read other pieces from Seeking Alpha's Positioning for 2014 series, click here.