By Philip van Doorn, MarketWatch
Look ahead to critically important technology as the traditional cloud isn't fast enough to do what people will want
The information technology sector has soared this year as the stock market has recovered from the doldrums of March, aided by massive government and central-bank stimulus. But the long-term cloud technology trend that has fed so much success for the largest tech companies can no longer be considered new and transformative.
Gerry Frigon, the chief investment officer at Taylor Frigon Capital Management, pointed to distributed computing as a critically important area for investors to think about. Another trend is probably already on your mind: the boom in working from home and the communication systems that make it possible.
He has two stock picks that he believes will capitalize on these trends: Tower Semiconductor (TSEM.TV) and AudioCodes (AUDC.TV).
Taylor Frigon Capital Management, based in San Luis Obispo, Calif., has about $280 million in assets under management. The firm's Core Growth Strategy has performed very well against the broad market, as you can see below. The strategy focuses on finding innovative companies with excellent growth prospects that are "not yet well-recognized or fully valued." Technology stocks made up 54% of the portfolio as of June 30, and five of the 10 largest holdings had market capitalizations of less than $5 billion.
Distributed computing, or the mobile edge cloud
The traditional cloud model of having computing done on a server run by Alphabet (GOOGL) (GOOGL) unit Google, Amazon.com (AMZN) or Microsoft (MSFT) won't work quickly enough for the new array of hands-free devices, the Internet of Things (IoT) and automated vehicles, Frigon said during an interview.
He also said that the development of 5G networks is really about "the movement of the cloud to the edge."
"The paradigm of the past 15 years will start to break down," he said, citing George Guilder, the author of the book "Life after Google (/)."
With every automated vehicle becoming a mobile cloud, computing speed will be critical.
"The laws of physics limit what can be done at a distance because of latency problems -- the speed of light," Frigon said. Automated cars provide a perfect example of the need for distributed computing: "If a deer runs in front of your car, the processing has to be done instantaneously, or close to it. You don't have time to go into the cloud to a Google data center."
The same holds true for automated manufacturing.
Frigon named Tower Semiconductor as an example of a stock held within accounts that follows Taylor Frigon's Core Growth Strategy. The Israeli-based company has a market capitalization of $2.4 billion and trades on the Nasdaq exchange.
Tower Semiconductor specializes in analog microchips, which can translate binary data (the ones and zeros processed by digital chips) into wave forms (including language) that people can understand. Frigon said the stock is a diversified way to play the mobile edge cloud trend.
Four of the five sell-side analysts covering Tower Semiconductor rate the shares a buy or the equivalent, with a consensus price target of $25.03, according to FactSet. That implies 14% upside potential over the next 12 months, based on the closing price of $22.01 on July 21. Analysts expect the company's sales this year to increase only 3% from 2019, but for 2021, they expect sales to rise by 8%. The company earned a dollar a share in 2019. Analysts expect earnings per share to increase to $1.03 in 2020 and to shoot up to $1.49 in 2021.
Work and communicate at home
It's understandable if you think first of Zoom Video Communications as the play for this trend. After all the stock has risen 314% this year, and sales during its fiscal first quarter ended April 30 were up 169% from a year earlier.
But Frigon suggests AudioCodes. The company provides equipment and services used in voice and video communications over the internet, and counts Zoom Video Communications and Microsoft among its customers. It, too, is based in Israel, is traded on Nasdaq and has a market cap of $1.2 billion.
The company hasn't yet reported its second-quarter results. For the first quarter, sales were up 12% from a year earlier.
Frigon said he had been holding AudioCodes shares for some time before the COVID-19 crisis because he thought remote working would be a growing trend. "Now it's on steroids," he said, adding that AudioCodes' shares are still "reasonably priced."
Four Wall Street analysts cover AudioCodes, according to FactSet, with three "buy" ratings and a consensus price target of $41.50 -- 6% above the closing price of $39.01 on July 21. Analysts expect a 9% increase in sales this year, followed by a 10% increase in 2021. EPS are expected to increase from 89 cents in 2019 to $1.05 this year and $1.28 in 2021.
Revisiting two stock picks from 2019
Back in February 2019, Frigon named Nvidia (NVDA) and QuickLogic as good long-term investments in the semiconductor sector (). Here's how the two stocks have performed since that article was published:
That's an incredible disparity.
Nvidia has been tremendously successful, and Frigon believes the company will remain a key player as much of the mobile cloud will be "driven by its technology." He also pointed to its market value in excess of $250 billion -- unusually large for the firm's Core Growth Strategy. "To say we still own it gives you some idea of how highly we think of Nvidia," he said.
Analysts still love Nvidia, with 31 out of 40 rating the shares a "buy." However, the consensus price target of $406.82 is below the closing price of $413.14 at the close on July 21. The analysts expect Nvidia's sales to increase by 34% this fiscal year (which ends in January 2021), followed by a 17% increase in the following fiscal year. Per-share earnings are expected to increase from $5.79 last fiscal year to $8.17 in the fiscal year and $9.86 in the following fiscal year.
Frigon called QuikLogic "a real hard-luck story," because its suppliers in China were affected by the trade disagreement with the U.S. and hurt by the COVID-19 pandemic. The company said it completed an $8.1 million offering of common shares on July 21. Its market capitalization is now only $37 million, but Frigon believes the company is still "right in the sweet spot with respect to what is happening with IoT and low power, high efficiency chips that make possible hands-free and voice-enabled devices."
"We are very patient with our companies, as long as we think the are on the right side of the paradigm shift. For us to wait years for things to happen is not necessarily a problem. It is one of the reasons we have been able to do what we do."
Two out of three analysts polled by FactSet agree with Frigon, with "buy" ratings and a consensus price target of $6.17, pointing to 75% upside potential from the closing price of $3.52 on July 21. Sales are expected to increase 23% this year, followed by an expected 80% increase in 2021. The company lost $1.60 a share last year. For 2020, the analysts expect a loss of 79 cents a share, followed by a loss of 1 cent a share in 2021.
Here are the 10 largest holdings (out of 47) in accounts following the Taylor Frigon Core Growth Strategy, as of June 30:
Company Ticker Industry % of portfolio Total return - 2020 through July 21
Vapotherm Inc. US:VAPO Medical Specialties 5.1% 294%
Compugen Ltd. US:CGEN Biotechnology 4.7% 169%
Kornit Digital Ltd. US:KRNT Industrial Machinery 4.0% 61%
Fiverr International Ltd. US:FVRR Data Processing Services 3.0% 260%
Nvidia Corporation US:NVDA Semiconductors 3.0% 76%
Carvana Co. Class A US:CVNA Specialty Stores 3.0% 58%
Repay Holdings Corp. Class A US:RPAY Commercial Services 2.9% 62%
Wix.com Ltd. US:WIX Information Technology Services 2.9% 125%
Twilio Inc. Class A US:TWLO Software 2.7% 165%
Monolithic Power Systems Inc. US:MPWR Semiconductors 2.6% 40%
Sources: Taylor Frigon Capital Management, FactSet
Here's how the Taylor Frigon Core Growth Strategy has performed, after fees, against the S&P 500 index and two other S&P indexes over various periods through June 30:
Total return - 2020 Average return - 3 years Average return - 5 years Average return - 10 years Since inception (Jan. 19, 2007)
Taylor Frigon Core Growth Strategy 23.6% 20.7% 16.8% 15.3% 11.2%
S&P 500 index -3.1% 10.7% 10.7% 14.0% 8.2%
S&P 400 Mid Cap Index -12.8% 2.4% 5.2% 11.3% 7.7%
S&P Small Cap 600 Index -17.9% 0.6% 4.5% 11.2% 7.1%
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