Lesser Lights Among Tech's Glitterati

 | Apr 17, 2012 | 7:30 AM EDT  | Comments
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Stock quotes in this article:

aapl

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lnkd

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veco

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mflx

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klac

Apple (AAPL), LinkedIn (LNKD), Facebook with its forthcoming IPO, the recent purchase of Instagram by Facebook -- all this would be enough to convince ancient alchemists that the fastest way to riches is by turning ideas into tech stocks, not lead into gold.

Yet the tech world is filled with good companies that lack the name-brand recognition of Apple and Facebook. If you want to buy into the tech sector but don't want to chase the leaders and their high prices, consider these minor celebrities.

One example shining bright is Veeco Instruments (VECO), which is not in the computer business but which supplies equipment used to manufacture light-emitting diodes. LEDs are increasingly popular as their efficiency improves and price goes down. Veeco also provides process-equipment technology to manufacturers of solar cells.

Joel Greenblatt wrote an excellent book, The Little Book that Beats the Market, which describes a two-variable strategy for choosing stocks that are worth buying. I have automated this strategy (along with the strategies of other savvy investors), and it gives Veeco a strong recommendation.

The first variable considered is earnings yield, which Greenblatt calculates by dividing a company's earnings before interest and taxes by its enterprise value, which includes the amount of debt it uses to generate earnings. Veeco's earnings yield is 44.88%, which ranks it fourth among all the stocks in our database.

The second variable is return on total capital, which is found by dividing a firm's earnings before interest and taxes by its net working capital plus net fixed assets. Veeco's return on capital is 39.73%, ranking it 236th among the stocks in our database.

The Greenblatt strategy then ranks each stock on the basis of a combination of its ranking from the first two variables. In this case, Veeco comes out No. 25 among the thousands of stocks in our database. No question, this stock earns a strong recommendation.

Multi-Fineline Electronix (MFLX) is among the largest global flexible circuit manufacturers and assemblers. Handset makers use its products, among others. Peter Lynch, the legendary mutual fund manager, spelled out an investment strategy in his bestseller, One Up on Wall Street, which I automated, like I did with Greenblatt's strategy.

The Lynch strategy focuses on the P/E/G ratio, which is price-to-earnings relative to growth, and it measures how much the investor is paying for growth. A P/E/G of 1.0 ($1 for each percentage point of growth) or less is acceptable. Multi-Fineline earns a very desirable P/E/G of 0.57 by having a P/E of 16.76 and a growth rate of 29.63%, based on the average of the three-, four- and five-year historical EPS growth rates. Another variable in its favor is the absence of any debt.

The last lesser-known tech play I will tell you about is KLA-Tencor (KLAC), which holds a very strong position in the process diagnostic and control market. Chipmakers use PDC tools to analyze the semiconductor manufacturing process, detect defects during production and correct problems.

Like Multi-Fineline, KLA-Tencor is touted by my Lynch-based strategy. That is because the company's P/E/G is a desirable 0.52, based on a P/E of 11.86 and a growth rate of 23.092%, using the average of the three-, four- and five-year historical EPS growth rates. In addition, the company is doing a good job managing inventories, and debt is at a reasonable level.

As with virtually every industry, frontrunners are not the only ones making money and creating solid investment opportunities. Lesser-known companies, such as these three, have the potential to provide a good boost to your portfolio. If the high prices of tech's glittering leaders are worrying you, these companies should provide solace. They offer strong market positions with well-priced stocks.

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