Back to the future — Canadian software stocks
The best technology stocks are building a strong future, says this Canadian advisory. So which growing stocks have the most promise?
Saying “tech stocks” to many investors is a bit like yelling “skunk” at a barbecue.
Not many stick around for further conversation.
Yet technology stocks have gotten a bit of a bum rap. The wildly overvalued dot-com stocks are long gone. It’s been almost a decade since that bubble burst.
And they had very little in common with the Microsofts of the world, except the nerds on staff. The dot-coms just had fewer of them.
Hardware and software technology is absolutely essential to our society today. Why shouldn’t we invest in it?
Put it another way. What looks more promising these days — a successful software company, or anything to do with automobiles?
So when a leading small cap advisory takes a close look at software stocks, it’s time to pay attention.
KeyStone’s Small-Cap Stock Report, published by an independent research team, puts together a careful scorecard for twenty Canadian software companies.
The advisory doesn’t throw a bouquet of “buys” at its readers (the shares of its favourite stock in the group have risen so sharply that it’s currently a hold). Instead, it gives an honest appraisal of which companies promise the best results down the road.
A great place to start
This advisory is launching a series of Canadian sector reviews. But why start with software stocks?
The editors cite Bank of America/Merrill Lynch analyst Ms. Savita Subramanian, who says technology is “unusually attractive in its reward to risk characteristics, and has a lower beta than most cyclical sectors.” The lower the beta, the less the stock swings with the market.
One thing about the advisory’s group of companies catches the eye immediately — strong balance sheets. “Of course, this is if you define balance sheet strength via strong cash balances, limited total debt and low debt-to-equity ratios.”
In the current state of the economy, “a solid cash position on a per share basis and limited to no debt are a great place to start.”
But be careful, says the advisory. This does not mean that all of these firms are in the hands of skilled management. Equity or share offerings are the norm for these companies, which generally generate a good deal of cash and have less debt.
The trick is, which ones burn through the cash and which ones shepherd it wisely? It is the latter that add to the shareholders’ value with strong cash flow, and husband it for organic growth or acquisitions.
Wise use of cash
Exhibit A in the wise use of cash is this advisory’s favourite among software firms, Bridgewater Systems Corporation (TSX-BWC). It makes access control and policy management software for wireless networks. That is, if you’re logging on to a cell or smart phone, Bridgewater’s software lets you on to the network.
Bridgewater has seen its cash on hand and its shareholders equity grow substantially since it went public just over a year ago.
It has also seen its shares rise by over 60 per cent. That’s why it’s a hold for now. But you can buy on dips to the $4.50 to $4.75 range, says the advisory. It is trading at $4.96.
Behind Bridgewater in the advisory’s “elite” list of cash-smart software companies are six more firms.
Chartwell Techology Inc. (TSX-CWH) and CryptoLogic Limited (TSX-CRY) both make software for the gambling industry. Enghouse Systems Ltd. (TSX-ESL) is a specialist in interactive voice response systems. The Descartes Systems Group Inc. (TSX-DSG) develops supply chain systems widely used by the transportation industry; RDM Corporation (TSX-RC) provides the hardware and software for electronic check conversion and bill payment processing. The Xenos Group (TSX-XNS) helps companies manage their documents.
But a company must keep its cash flow growing internally. Among this group, CryptoLogic and RDM have both seen losses in the past year eat away at that precious supply of cash.
Price/earnings promise
There’s another criterion for future growth — an attractive price-to-earnings ratio. And four microcap software firms look good in this respect.
QHR Technologies (TSX/V-QHR) makes software for health care. Parlay Entertainment (TSX/V-PEI) makes software for bingo. Wanted Technologies Corporation (TSX/V-WAN) specializes in software for the headhunting business. Cyberplex Inc. (TSX-CX) deals with online advertising and marketing.
But dig deeper and not all of these stocks are on the same footing. QHR and Cyberplex can back up their p/e promise with strong revenue and earnings growth despite the economic slump.
Parlay and Wanted, on the other hand, have seen their revenues and earnings dwindle during the slump. Their p/e ratios are not as attractive on a second look.
As promised, there are no extravagant promises from this advisory.
We know that Bridgewater is a buy on price dips. Chartwell Technology has promise as a turnaround candidate or takeover target, “but we would not chase the shares as the near-term business outlook is Neutral or Negative.”
QHR Technologies and Cyberplex look good thanks to their growth and reasonable valuations. But both have had solid runs — and a pullback over the summer could signal buying opportunities. Finally, The Xenos Group is a solid candidate thanks to its strong cash per share and profitable growth.
Just a glance at the specialties of each of these stocks reminds us how deeply embedded technology has become in our lives. So it isn’t a matter of whether tech stocks will do well, but which ones?
This advisory’s list seems as good a place as any to start.
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