The Next Wave Portfolio

05/14/2014 10:00 am EST


James Pearce

Director of Research, Investing Daily

The Smart-Tech Investor newsletter has just launched a "Next Wave" portfolio, focused on small-cap stocks in the emerging markets for big data, mobility, cloud computing, and social media. Analyst Jim Pearce discusses these markets and best stocks poised to grow with these trends.

Steven Halpern: Joining us today is Jim Pearce, Editorial Director of Investing Daily and analyst for the Smart-Tech Investor. How are you doing today, Jim?

Jim Pearce: I'm doing great, Steve. How are you?

Steven Halpern: Very good. Thanks for joining us. In Smart-Tech Investor, you use a proprietary model called the Boeckl Innogration Quotient (BIQ) which isolates stocks that are establishing themselves as-what you consider to be-long-term winners within their respective categories. Could you give us a quick overview of this model and how you apply it to the newsletter?

Jim Pearce: Sure, I'd be happy to. It's named after Leo Boeckl, who is my partner on Smart-Tech Investor. Leo's been in the technology industry for over 20 years and has spent about 15 years at IBM as a technology strategist; basically, evaluating the trends in the tech sector and where technology is going.

He and I got together about five years ago and started discussing whether or not there'd be some way to actually predict, not necessarily which technology products are going to be the next big winners, but which companies are going to produce them.

As far as we know, we're the only people taking this approach; so what we did is, we created a formula that measures the distinct features, or the elements that we feel those companies possess that will be the ones to ultimately create market leading products and become the long-term tech winners.

That's what we call the Boeckl Innogration Quotient. It's something that we provide on a constant basis to the universe of technology stocks that we cover on Smart-Tech Investor.

Steven Halpern: The last time we spoke, you offered two specific stock forecasts that were based on this innogration quotient, and you considered Apple (AAPL) the top tech stock to own for 2014, and, at the same, time you considered Amazon (AMZN) a sell, both calls that proved very timely since, a few months back. Could you update us on your outlook for these two companies and what the quotient is saying now?

Jim Pearce: Sure, I'd be happy to. Back in December, when we launched Smart-Tech Investor, we did name Apple as the one stock to own in 2014. That doesn't necessarily mean it's the tech stock that's going to appreciate the most. We felt it was the safest bet and the most likely tech stock to produce very good returns.

Obviously, when you're talking about a stock that prices $400, to $500, to $600 a share, in percentage terms, it's hard to realize as much of a gain on a stock that's only priced $20 or $30 a share; but we felt, given that the fed would start tapering, Apple was the company that was the best bet to do well in what might be a difficult year.

So far, of course, that prediction is turning out very good. At the same time, Amazon was the second lowest scoring stock of all the tech stocks we measure using the Boeckl Innogration Quotient.

In addition to assigning a score based on the Boeckl Innogration Quotient, we then convert that score based on forward 12 months' earnings for that company compared to all the other companies in its sector; and, on that basis, Amazon was the lowest scoring stock of all the ones that we covered.

In our January issue of Smart-Tech, I came out and said, look, if you're ever going to short Amazon now's the time to do it. At that time, Amazon was trading right around $400 a share, actually got a little over 400, and everybody thought it was going higher.


However, shortly thereafter, it dropped down in the 300s and, quite frankly, even then Leo and I feel right now that the highest value we can justify for Amazon, even being generous in our assumptions, is about $250 a share.

Right now, as we speak, it's at about $290, so, quite frankly, we think it still has at least another $40 to drop. Meanwhile, Apple is bouncing around $600 and its most recent quarterly earnings report was very positive.

They're splitting seven-for-one next month so they can be included in the Dow, and there are just an awful lot of positive things going on; so it appears that our Boeckl Innogration Quotient was dead on both these stocks.

Steven Halpern: You've recently introduced a big change at Smart-Tech Investor by launching a new portfolio called the Next Wave. Can you explain how this new portfolio will differ from the current approach that you use?

Jim Pearce: Sure. We can still calculate the BIQ for these smaller-cap companies, but we acknowledge that companies early in their growth curve aren't necessarily going to score out as accurately, so we overweight the one subjective element of the BIQ,, which is what we call the strategy score, and we underweight the financial metrics.

With companies like this, it's more important that they're in the right space and that they are doing the right things to capture enough market shares, so as that market grows, their financial results in the future will reflect that.

We don't put as much weighting on the traditional metrics that we use in the BIQ, but we still use it and we still use that as a guide, but these are really companies, we think, are still a couple of years away from becoming the next Apple or the next Amazon.

Our metric works particularly well with large-cap stocks, and we think it's useful with the small-cap stocks, but we are using more subjectivity with these smaller-cap stocks in the Next Wave portfolio.

Steven Halpern: So, with the launch of this Next Wave portfolio, you focused on four specific sub-sectors of technology, big data, mobility, the cloud, and social computing. Perhaps you'd be kind enough to share an investment idea in each of these categories and let's begin with big data.

Jim Pearce: Sure. Big data, of course, now is, really, pretty much, can't go a day without hearing somebody talking about big data. If you think about it, that's really where the combination of cloud and increased processing capability really manifests itself in terms of businesses being able to use that information to do all sorts of things.

The small-cap company that we just added to our Next Wave portfolio is called Nice Systems (NICE).

It's a company, based out of Israel, that works on cyber-crime and -terrorism, and has state of the art technology to help banks and other financial institutions prevent people from hacking into their systems. It's also used a lot by airports and other types of facilities that can be victimized by terrorism.

By the way, they just announced earnings that were a little bit disappointing and the stock dived down, so we actually think now, it's an even better buy where it is now; but Nice Systems is the company that, we think, five years from now could be a very large company.

Steven Halpern: Okay, so let's look at the mobility sector. What do you see happening there?


Jim Pearce: Well, mobility is a little tougher to define. We like a company called Silicon Motion Technology Corp. (SIMO). It's actually a Korean company, based out of Taiwan, and it designs and markets advanced semiconductors that expand the storage capacity of handheld computing devices like smart phones, tablets, iPads, and cameras.

The semiconductors also use less power than a standard processor so it extends the battery life of these devices. Mobility is huge, particularly in Asia, where they're leapfrogging over the whole PC market and going straight to things like smart phones and tablets.

A company like this, that can offer a semiconductor that both increases storage capacity, and reduces battery usage, is going to be enormously popular; and just the rate at which that market is growing it's hard to imagine this company five to ten years from now won't be ten times the size it is now.

It's trading at a 20% discount through its peer group on forward earnings, and it pays a dividend of over 3%, so we kind of view that one as a no-brainer, so to speak.

Steven Halpern: You've touched on cloud computing as a sub-sector that you have a favorable outlook for. Is there a specific stock in that area that you're looking at?

Jim Pearce: Our first stock in the Next Wave portfolio in the cloud category is a company called Ebix (EBIX). It actually works in the insurance industry and, basically, what it's doing is bringing the insurance industry into the 21st century.

Obviously, for an insurance company to be profitable, they have to crunch a lot of data and they have to be able to rate policies accurately, otherwise, all their other numbers don't work.

What Ebix is doing is using the cloud to create kind of a central clearing house of information similar to how the medical industry uses information on individual patients.

But here, it's more of a business to business proposition where underwriters and insurance companies can all go to the cloud and look at current data and be able to properly rate policies and price them and things of that nature.

People think of the insurance industry as being, kind of, stodgy and boring, but in truth, there's an enormous amount of money controlled by the insurance industry, and a company like this, that can provide a productivity enhancement tool, should grow dramatically, but it's valued like an insurance company.

It's only trading at ten times forward earnings and it's paying a dividend of almost 2%, when, really, it should be valued more like the small-cap growth tech stock that it is. Ebix is the small-cap cloud company we like.

Steven Halpern: Finally, you also like the long-term prospects in social media. Is there a company there that you would suggest?

Jim Pearce: We do, and it's really not a pure social media company, but we believe social media is morphing into something else. We saw Facebook (FB), for example, recently acquire Oculus, which is a 3D, kind of, goggle viewing system, and at that time, Mark Zuckerberg even said that he felt that social, and gaming, and that sort of thing were, sort of, converging.

There's a company in China called KongZhong Corp. (KONG), just like in King Kong. It's the closest thing to a pure play on the Chinese mobile gaming market you'll find.

If you think about the growth of just computer usage in China, as well as the extent to which the youth market really uses social and the Internet for gaming, again, this is one of those companies that's just hard to imagine that, five to ten years from now, this won't be an enormous company.

It's got annual sales last year of 174 million in an industry estimated at 82 billion, so there's enormous room for KONG to grow its market share.

It manages to maintain profit margins of about 12%, and with the rate at which that entire industry's growing, we don't think they're going to need to cut margins to grow, so we think KONG is going to be a future superstar in social computing stocks.

Steve Halpern: Again, congratulations on the launch of the Next Wave portfolio. We wish you the best of luck and thank you very much for joining us today.

Jim Pearce: Thank you, Steve. I enjoyed the call.

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