Hidden value is one of the key factors we look for when we choose stocks to recommend in our newsletters and investment services, including Stock Pickers Digest, our newsletter for aggressive investing.
(In the latest Stock Pickers Digest, we’ve updated our buy/sell/hold advice on a niche technology firm with an important hidden asset. Read on for further details.)
By hidden value, we mean valuable assets that are not getting the attention they deserve from investors. When a company’s assets are wholly or partially hidden, the stock trades for less than it’s really worth, so you get to buy at a bargain price.
High research spending makes tech stocks look less profitable than they really are
One of the key hidden assets we look for when we’re analyzing tech stocks is high research spending. That’s because tech stocks have to treat their research spending as a day-to-day expense, much like maintenance or taxes. So research spending comes out of the current year’s sales, and it lowers the current year’s earnings. That makes technology stocks with high research spending appear less profitable than they are.
As a result, many tech stocks’ earnings per share may look lower than those of companies in other sectors. That causes some investors to overlook promising tech firms, or see them as overpriced.
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However, research spending has the potential to pay off in dramatic long-term returns. That’s because the products that grow out of this spending will help tech stocks increase their long-term sales and profits.
This tech stock’s research spending is high—and rising
In the latest Stock Pickers Digest, we update out buy/sell/hold advice on Computer Modelling Group (symbol CMG on Toronto). The company sells software to clients in the oil and gas industry. Its software helps companies use advanced oil-and-gas recovery techniques to raise output from their existing wells. The company also provides consulting services.
In its latest quarter, Computer Modelling’s revenue rose 3.4%, to $12.1 million from $11.7 million a year earlier. That’s because it sold more of its consulting services to both new and existing customers. However, its earnings fell 10.9%, to $3.6 million from $4.0 million, mainly because the company added employees to support its continued growth.
Computer Modelling also spent more on research: in the latest quarter, its research spending rose 8.8%, to $2.3 million, or a high 18.9% of its revenue.
Oil and gas exposure gives this tech stock potential—and adds risk
Computer Modelling is a leader in complex heavy-oil and oil-sands simulations. That puts it in a good position to profit as natural-gas producers continue to develop other unconventional sources, such as shale gas. (Shale gas is natural gas that is trapped in rock formations. To extract it, companies must pump water and chemicals into the rock. This fractures the rock and releases the natural gas.)
However, the company’s focus on the volatile oil and natural-gas sector also adds risk. As well, the stock has risen 52% in the last year. That makes it vulnerable to a setback if it experiences a quarter of bad earnings, for example.
In the latest Stock Pickers Digest, we take a close look at the company’s growth plans, and the outlook for oil and gas, and see what they could mean for its share price.
You can get our latest buy/sell/hold advice on Computer Modelling Group and 22 other stocks that may be suitable for the part of your portfolio you devote to aggressive investing in the latest issue of Stock Pickers Digest. What’s more, you can get the latest issue free. Click here to learn how.
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