Three small-cap tech stocks that look set for a rebound

 In Small Cap Upgrades

Three small-cap tech stocks that look set for a rebound

Investors who think the stock market is heading lower probably shouldn’t be buying technology stocks since they usually do poorly in a risk-off environment and are more volatile than most other sectors.

October 15, 2015
Jonathan Ratner
Posted from Financial Post

Peregrine’s Tom Antony thinks the worst of the market pullback is over and these companies stand to gain the most as disrupters in their sectors

Investors who think the stock market is heading lower probably shouldn’t be buying technology stocks since they usually do poorly in a risk-off environment and are more volatile than most other sectors.

That’s even truer for small caps. But Tom Antony, president and portfolio manager at Toronto-based Peregrine Investment Management, thinks the stage is set for healthy gains in small-cap tech since he believes most of the pullback in equities is over.

“I believe the market is currently in a mid-cycle correction, not a major downturn,” he said, adding that while the start of an interest rate tightening cycle can cause a market correction, it usually does not lead to a bear market.

Antony also doesn’t see any significant bubbles in the financial system, and although there was some excess in the biotech sector, stocks there have started to roll over. Similarly, a ton of money flowed into shale oil companies, and that too is being unwound.

“I don’t think stocks are expensive as a whole,” Antony said, noting that valuations are close to their historical averages. “Retail investors haven’t been fully committed to this market since 2007, and market tops usually coincide with retail investors plunging in with both feet.”

The portfolio manager of the Peregrine Investment Management Fund LP, which has approximately $100 million in assets and has produced a compounded return of nearly 400 per cent since its June 2004 inception, targets small caps because they tend to grow faster than their large-cap counterparts. Small caps are also more likely to be mispriced.

With a history of managing technology funds, it’s a natural place for Antony to focus on. Typically, 50 to 60 per cent of the portfolio is in tech stocks, with the majority of those being small caps.

There is no shortage of interesting tech companies coming out of North America, but Antony highlighted three that are disrupting their respective industries.

One, Ottawa-based Shopify Inc. (SH/TSX), is a recent IPO that helps businesses conduct commerce online.

“The market is very large and this company is an emerging leader,” Antony said, highlighting Shopify’s annual growth rate of about 100 per cent. “They have a really good solution and a lot of growth ahead.”

That was made evident in the company’s recent partnership with Amazon.com Inc., which told its vendors to switch to Shopify’s platform.

Antony also has a position in another Ottawa-based company, Kinaxis Inc. (KXS/TSX). He noted that the provider of supply chain management software has such a strong product offering that it often wins contracts over larger companies such as SAP SE and Oracle Corp.

“They operate in a large market and have a high win rate despite being a smaller company with not as broad an offering,” he said. “I believe they will grow much larger, or get acquired by a bigger company, because they have an excellent product that is not easy to replicate.”

Kinaxis’s stock has come down slightly in recent weeks, but Antony noted that it is still a high-quality name that few investors want to sell, even while sentiment toward tech stocks becomes negative.

A third pick, BofI Holding Inc. (BOFI/Nasdaq), is a tech-financial services hybrid that came under selling pressure this week due to a lawsuit from a disgruntled employee. Antony knew about the issue as the company addressed it during a conference call a few weeks ago. “I believe it will blow over,” he said.

He also noted that BofI recently acquired some assets from H&R Block, so federal regulators have reviewed the company and gave it the all-clear.

The San Diego-based company is a pure Internet bank. That means it doesn’t have any physical branches, which could be a concern since it makes it more difficult to check out potential loan applicants.

But Antony said BofI focuses on high-quality loans, which served it well in 2008 when the global financial system almost collapsed.

“A lot of banks would have gone bankrupt were it not for the government, but this one had no problems,” he said, noting BofI’s annual growth of more than 30 per cent.

BofI’s stock trades at a premium to physical banks at about 15x earnings, but Antony thinks that’s justified given its much faster growth.

“I think Internet commerce is here to stay, and it’s affecting all sorts of businesses, including banking,” he said. “I wouldn’t be surprised if this company got bought by a larger institution, which is certainly what happens in Canada whenever we have Internet banks.”

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