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Published: November 1, 2010
Microsoft
(Nasdaq: MSFT) is a compelling investment. Analysts expect
the software giant's stock to return +70% to +110% during the
next three or four years.
Furthermore, its current
price-to-earnings ratio (P/E) of 12 looks cheap next to its
five-year average P/E of 19 and the industry average of 19. At
about $26, its shares are discounted -19% from their one-year
high.
But as bright as the future appears to be for Microsoft, it
probably won't keep pace with a mid-size tech firm I like.
Although this firm is only a tenth the size of Microsoft in
terms of market cap, it's the world's leading maker of automated
test equipment for semiconductors, telephone lines, circuit
boards and software. It also makes circuit board connectors
(known as backplane systems) for the military/aerospace,
computer and communications industries.
From its current price of about $10.80, this stock is projected
to rise as much as +175% -- +65% more than Microsoft's estimate
-- during the next three or four years.
Assuming the predictions prove accurate, $10,000 invested in
Microsoft now could grow to as much as $21,000, excluding taxes
and account fees. Though very good, that's still $6,500 less
than the $27,500 you might have in three or four years, again
excluding any expenses, if you put the $10,000 into this
mid-cap tech stock.
That company is Teradyne (NYSE: TER), and it's just the
kind of behind-the-scenes player I prefer. Whereas an outfit
like Microsoft is so often in the public eye, Teradyne quietly
goes about its business of providing crucial support services to
higher-profile tech, communications and other companies. That's
how it has operated for more than five decades.
A diverse portfolio
Teradyne has a large portfolio of products, but one of its key
offerings is the J750 system. This system tests microcontrollers
and other semiconductor devices found in the electronic
components of things such as automobiles and home appliances.
Another major Teradyne product is the FLEX test platform, which
is used to assess the function of a range of consumer
electronics including cell phones, HDTVs and video game
controllers.
A couple years ago, Teradyne
acquired Nextest Systems to expand its ability to test
microcontrollers, image sensors and other types of integrated
circuits. Around the same time, it bought Eagle Test Systems to
gain access to testing systems for the various types of radio
frequency semiconductors found in digital cameras, MP3 players,
notebook and desktop computers and many other types of
electronics.
Back from the doldrums
After a couple lean years, Teradyne is impressively rebounding.
Sales more than doubled in the second quarter to $390 million
from $115 million in the second quarter of 2009. It just
reported third quarter sales of $502 million, a +92% increase
over the same period a year ago.
Per-share earnings have bounced back, too, to $0.69 in the
second quarter and $0.82 in the third quarter -- astounding
increases of +393% and +382%, respectively, over the second and
third quarters of 2009. For all of 2010, Teradyne is on course
to generate total sales of more than $1.7 billion and earn $2.40
a share -- by far its best showing in years. Analysts project
annual earnings will grow by +17.5%, on average, through 2015.
Lately, Teradyne's success has been mainly in the
mobile/wireless and microcontroller markets, though demand for
its products has been strong across many electronics sectors.
The company is also expanding into new areas such as hard drives
and flash memory. And it has been reducing expenses. For
example, product and service costs (as a percentage of sales)
have fallen from more than 70% to about 50% this year.
Now an even better value
When Teradyne announced its +382% increase in third quarter
earnings on October 27, its shares plunged by more than -10%,
from about $11.75 to $10.60, then bounced around a bit before
settling around $10.80. Odd, yes, but it's just the sort of
thing you might expect from the market, which was overreacting
to the likelihood that Teradyne's fourth quarter won't measure
up to its second and third quarters.
It doesn't bother me, though. If Teradyne was a cheaper buy than
Microsoft before, now it looks like an even better value by
comparison. Its lower P/E of 10.7 is one good indicator of that.
An even better sign is its EV/EBITDA ratio of 5, versus 7 for
Microsoft. Furthermore, Teradyne shares are nearly -20% off
their one-year high and -40% below their five-year peak.
Action to Take --> Don't
let the recent price gyrations spook you. Teradyne is, after
all, a mid-cap firm, and that sort of crazy, short-term stock
price behavior goes with the territory. Focus instead on the
company's long-term prospects, which point to outperformance. If
you buy the stock and hang in with it for at least a few years,
you'll likely leave the overall market and much bigger, better
known tech players like Microsoft in the dust.
-- Tim Begany
Contributor
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