Size Matters for Network Gear Makers

07/06/2011 9:30 am EST

Focus: STOCKS

Kate Stalter

CMO & Senior Financial Advisor, Better Money Decisions

If you can look past Cisco, there are a slew of younger up-and-comers in the sector that are poised for breakouts, writes MoneyShow.com contributor Kate Stalter.

In recent months, many growth investors have shunned beaten-down large-cap computer networking stocks such as Cisco (CSCO) and Juniper Networks (JNPR).

However, it would be a mistake to assume the entire sub-sector is in the doldrums. Several small- and mid-caps have been rallying to new highs—outpacing not only larger peers, but also the broader market.

Polycom (PLCM), which makes gear that helps business integrate video, voice, and other data, split 2-for-1 on Tuesday. The stock climbed 6.5% last week, although trading volume was below average. Higher trading activity is often an indication of conviction among institutional investors.

Shares of the Pleasanton, Calif.-based company cleared a somewhat sloppy price consolidation last Monday, and held its gains throughout the week. The stock continued ascending on Tuesday, post-split.

It’s currently a bit extended out of its previous consolidation, so potential buyers would be wise to wait for the next pullback before attempting to enter the stock.

Fundamentally, the stock remains promising. Earnings growth has accelerated for four straight quarters, from 7% to 66%. Revenue has increased at rates of 23% or more during that time.

Wall Street sees Polycom earning $2.18 per share for the year, a gain of 45% over 2010. Next year, Wall Street expects the company to earn $2.78, up another 28%.

Another mid-cap in the business of making networking gear is Riverbed Technology (RVBD). The stock jumped 14.9% last week in above-average trading volume, retaking its ten-week moving average.

Early Tuesday, Oppenheimer downgraded the wide-area network optimization specialist to Perform from Outperform on valuation concerns. Last week, the company released a bullish research note on Riverbed, saying that it expected second-quarter revenue to come in higher than expected.

Oppenheimer’s analyst stood by that assertion when he issued his downgrade, but noted that the stock’s price had raced too far, too fast.

Riverbed fell 2% Tuesday on the downgrade, but remains well above its key 50-day moving average. While stocks often decline after an analyst’s demotion, the effects frequently are short-lived. Professional investors who continue to have confidence in the stock can use the pullback as an opportunity to scoop up more shares at a lower price.

Despite Oppenheimer’s concerns that the stock has become frothy, it actually has some more work ahead to regain its previous high of $44.70, reached in March. Individual growth investors are generally better served by waiting until a stock’s price is within a few percentage points of its old high, rather than trying to guess when a stock has bottomed.

If Riverbed’s sales and earnings forecasts pan out as expected—or beat expectations—the stock’s price could see further upside. Wall Street sees earnings of 89 cents per share this year, a gain of 51% over 2010. Next year, the company is expected to bring in per-share profit of $1.17, up an additional 31%.

One networking-industry stock that’s trying to stage a technical breakout is NetGear (NTGR). Last week, the maker of routers and modems for homes and small businesses cleared its late-April high, but it pulled back to end Friday about 30 cents below that price.

On Tuesday, it was once again flirting with that level, but was having trouble overcoming resistance to notch a definitive move higher. The stock is currently within a technical buy range, though I’d like to see heavier-than-normal volume to confirm investor conviction.

A small-cap that has been a solid price performer is Israel-based Allot Communications (ALLT). The company makes hardware and software to optimize network traffic.

This is another example of a stock that has struggled with resistance in recent months. Until last week, it failed to muster up the strength to move beyond its $16 to $17 range on the top side.

Like Riverbed, it dropped sharply Tuesday, but remained above key trend lines. Allot shed 6% early in the session. There was no specific company news, so the gap-down could represent an opportunity for buyers, if the stock continues getting support above short- and medium-term moving averages.

When looking at a whipsaw move like this, it’s important to keep the company’s small size in mind. Allot has a market capitalization of only around $390 million, and it trades about 173,000 shares per day. That puts it in the ranks of thinly traded issues, and can make the stock more prone to volatility.

Evidence of the volatility can be found in the stock’s beta of 1.54. Though a growing number of US-based mutual funds and hedge funds have purchased Allot shares in recent quarters, it’s still not quite an institutional-quality stock, due to the low liquidity.

For individual investors who are able to withstand some volatile trading, Allot could be a name to watch. If it is able to rebound past last week’s high price of $18.74 in heavy volume, that could be a fresh buy signal.

Techs have been among the stocks showing the strongest resilience in the young market uptrend. It’s an excellent time to continue tracking some of these promising names, so you’re ready when the next technical buy opportunity arrives.

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