As you’ve likely come to realize over the past few weeks, I’m a rules-based investor when it comes to tech stocks.
However, there are investments out there that don’t pass the rigorous five-part system found in “Your Tech Wealth Blueprint” – but are still worth taking a look at.
I call these “Special Situations” – or turnaround plays – and I want to share one of them with you today.[ad#Google Adsense 336×280-IA]I’m looking for this $9 stock to soar 50% in less than three years.
Now, not every Special Situation can succeed in its turnaround and produce those kinds of gains.
That’s why I also have a set of rules when it comes to determining if these kinds of investments will become lucrative.
In fact, there are three tell-tale catalysts that can help you find these big-profit tech stocks.
Let’s take a look…
Back in Winning Form
To succeed at turnaround investing, you have to be willing to put your hard-earned money into companies with steep losses. So, the five rules I talk about so much have to go right out the window.
Take the case of FormFactor Inc. (Nasdaq: FORM). This supplier of specialized test equipment to the semiconductor industry has a market cap of $509 million and trades at about $9 a share.
However, the true cost of buying a share of FormFactor is closer to $6.15, because the firm has $164 million cash on hand and no debt. That gives it net cash per share of $2.75, lowering your “true cost” by about 30%. (If the firm were to liquidate, $6.15 is how much per share you’d be entitled to receive.)
Why the discount? The company’s stock sank in late 2009, after the International Trade Commission ruled that two competing firms had not infringed FormFactor’s patents. It then reported losses amid a weak economy.
Now, I’ve been “screening” FormFactor for a while, and after doing this math, I knew now was the time to take a closer look.
I wanted to see if the Livermore, Calif.-based company triggered all three catalysts I use to judge whether a company is a solid turnaround candidate.
It did, indeed, and that’s why I’m recommending it to you today.
Let’s see how that works…
Tech Stocks Turnaround Catalyst No. 1: A Solid Recovery Starts at the Top
I never even consider investing in a turnaround until I take a good look at management.
I like to see fresh blood at the top for a simple reason: When companies get into trouble, it often follows from a series of bad decisions by senior management. So, if the company needs to go in a new direction, that requires execs who will bring in new ideas and approaches with them.
I’ve been a turnaround investor ever since the early 1980s. That’s when I met with Lee Iacocca, the CEO behind Chrysler Corp.’s turnaround. And as he explained to me then, if a board of directors isn’t willing to change leaders, it isn’t serious about righting a sinking ship.
To get FormFactor moving forward, the company hired a savvy new CEO back in 2010. Thomas St. Dennis had served two stints at chip industry leader Applied Materials Inc. (Nasdaq: AMAT), where he ran the division that makes machines for semiconductor manufacturing.
He had also held senior positions at a leading maker of silicon wafers and a privately held firm that makes semiconductors embedded in cars, jets, and medical products.
So, he brought in a bird’s-eye view of the entire global chip industry.
St. Dennis immediately started installing new managers in FormFactor’s executive suites. Of his six top lieutenants, four assumed their jobs since St. Dennis became CEO. In other words, he surrounded himself with proven leaders who share his goals and vision.
And he recently moved one of those new hires into the top slot. Fortunately for FormFactor’s investors, St. Dennis will now serve as chairman of the board, meaning we’ll still have a steady hand at the top.
St. Dennis’s replacement previously served as CEO of MicroProbe Inc., which FormFactor acquired in late 2012.
Mike Slessor, who earned a Ph.D. in aeronautics and physics at Caltech, is a seasoned semiconductor leader. Before joining MicroProbe in 2008, he held management positions at mid-cap semiconductor leader KLA-Tencor Corp. (Nasdaq: KLAC).
Tech Stocks Turnaround Catalyst No. 2: It Must Find New Growth
To convince key customers, lenders, and investors that it has embarked on a new direction, a once-troubled firm has to offer more than just lip service. It must have something new to deliver. This can include new products, markets, or ways of doing business.
In FormFactor’s case, the company did all three at once by pulling off a big merger. In late 2012, it agreed to acquire MicroProbe for $100 million in cash and roughly $16 million in stock.
The merger made FormFactor the semiconductor industry’s largest supplier of probe cards. Basically, these are printed circuit boards like you’d find in any piece of electronics made today. But they’re specially designed to check the quality of circuits contained in the large wafers used to make silicon chips.
Picking up MicroProbe moved FormFactor into the markets for checking the quality of memory systems used in computers and other electronic gear. It also picked up a line of systems-on-a-chip products, which are used for advanced semiconductor testing.
The MicroProbe acquisition also moved FormFactor into the rapidly growing mobile market. Right now, smartphones and tablets are outselling desktops and laptops by a factor of nearly 5-to-1. Mobile devices are on pace to capture more than one-third of the global tech economy.
Fortunately for FormFactor, mobile chips are significantly simpler than the ones that go into PCs. That allows the firm to build less complex and, therefore, cheaper test cards to a growing market.
In other words, we only want to invest in turnarounds that meet Rule No. 4 of my five-part strategy for building wealth through high tech. And that says to “Focus on growth.”
Tech Stocks Turnaround Catalyst No. 3: The Company Must Improve Its Financials
In all the years that I’ve analyzed turnaround firms and their stocks, I’ve yet to see one that didn’t need at least some improvement in its balance sheet.
Of course, we like to see lots of new sales. But if the firm can’t improve its cost structure, sooner or later it’s going to end up in financial trouble.
Here, FormFactor is on the right track. It still has plenty of work ahead, but its financials have greatly improved over the last several quarters.
Just take a look at the results of 2014′s fourth quarter. For the period ended Dec. 27, revenue jumped some 47% from the year-ago quarter to $71.3 million.
And earnings improvements were just off the charts. FormFactor reported earnings per share of $0.11. During the same quarter in the previous year, the company posted losses of $0.20 per share.
In other words, earnings are improving by wider margins than sales, a sign of a true improvement in operations.
During 2013′s fourth quarter, FormFactor had a negative cash flow of ($5.2 million) – a drain. But a year later, it had cash flow of $9.5 million. That’s a nearly $15 million improvement.
Investors are waking up to the great turnaround story at FormFactor. Over the last year, the stock is up 37.1%. But I still see plenty of upside ahead.
As I figure it, the company is on track to double its earnings in just three years. And if the price only tracked half that amount, we’d be looking at gains of 50% over the same period – and 27% or more in the next year.
My five Tech Wealth Rules still hold. But there are exceptions.
And FormFactor is one of them – clearly, it’s making all the right moves.
— Michael A. Robinson[ad#wyatt-generic]
Source: Money Morning