2 high-tech stocks to buy

We regularly review 10 high-technology stocks on The Back Page. Some are popular but look overpriced. Here are two that we rate as ‘buy’.

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High-tech stocks are popular–and often overpriced. Here are two that remain ‘buys’.

We continue to rate Toronto-based high-tech stock Constellation Software Inc. (TSX—CSU) a buy. It “acquires, manages and builds vertical market software businesses that provide mission-critical software solutions”.

CSU is doing well. In 2021, its earnings are expected to jump by more than 27 per cent to C$55.95 a share. As a result, the shares trade at a hefty P/E (price-to-earnings) ratio.

Next year, the company’s earnings are expected to grow to C$65.06 a share. Based on this estimate, the shares trade at a better, but still-hefty forward P/E ratio.

CSU has done well these past five years

Since we published our November 20, 2020 issue, CSU’s shares have advanced by 14.1 per cent.

From a longer-term perspective, they have handily beaten the overall stock market. Specifically, over the five years to December 31, 2020, the shares have generated total returns of 202 per cent. Total returns are share price gains and dividends. This is far ahead of the S&P/TSX Composite Index’s corresponding total return of 56 per cent. In other words, CSU’s shares have upwards price momentum.

On February 17, 2021, CSU subsidiary Volaris Group acquired SSP Limited. “SSP has grown to be a leading global supplier of technology systems and software for the property and casualty insurance industry.” This marks Volaris’ seventh acquisition in Insurance and Benefits. Cross-selling products should further drive CSU’s revenue and earnings.

CSU can use its strong balance sheet and cash flow to make acquisitions. On December 31, 2020, its cash of US$758 million exceeded total debt of US$725 million. That is, the company had no net debt. Last year, it generated cash flow of US$1.069 billion. This will keep its net debt-to-cash-flow healthy.

CSU has focused on its growth more than its dividends. It pays dividends of US$4.00. That translates to about C$5.0258 a share. This works out to a yield of only 0.28 per cent. Constellation Software remains a buy for long-term share price gains and small dividends.

Buy EXFO if you need no dividends

We also rate Quebec City-based EXFO Inc. (TSX—EXF) a buy, but only if you need no dividends. Its shares have jumped by 59.1 per cent since we published our November 20, 2020 issue. This momentum means that they could just keep on going up.

EXFO formerly went by the name Exfo Electro-Optical Engineering. Today it “develops smarter test, monitoring and analytics solutions for our fixed and mobile network operators, web-scale companies and equipment manufacturers in the global communications industry.

“Our customers count on us to deliver superior network performance, service reliability and subscriber insights and services to accelerate digital transformations related to fiber, 4G/LTE and 5G deployments.

“Our customers count on our expertise with automation, real-time troubleshooting and big data analytics which are critical to their business.

“1,900 EXFO employees in over 25 countries work side-by-side with our customers in the lab, field, data center and beyond”. This gives the company geographical diversification.

InOpticals should restore EXFO’s earnings

The COVID-19 pandemic has restricted “side-by-side” work. That’s partly why EXFO earned only C$0.01 a share last year. In the year to August 31, 2021, EXFO is expected to earn a much better C$0.31 a share. Based on this year’s earnings estimate, the shares trade at a P/E (price-to-earnings) ratio of 17.8 times. In fiscal 2022 (which starts on September 1), EXFO’s earnings are expected to jump by 16.1 per cent, to C$0.36 a share. Based on this estimate, the shares trade at a reasonable forward P/E ratio of 15.3 times.

On December 31, 2020, EXFO closed the acquisition of Taiwan-based InOpticals Inc. That company provides “ultra-high-speed test instruments for the laboratory and manufacturing sectors”. Specifically, InOpticals supplies sampling oscilloscopes, bit-error rate testers and other critical test instruments to optical component and network-equipment manufacturers.

EXFO can afford to invest

EXFO founder and executive chairman Germain Lamond said: “EXFO has made strategic investments in recent years, both internally and through acquisitions, to increase our footprint in the rapidly-growing laboratory and manufacturing segments. This latest acquisition raises our T&M (Time and Materials) addressable market to more than US$1 billion by expanding our high-end portfolio related to 400G and 800G technologies. Ultimately, it will allow EXFO to strengthen its leadership position in R&D (Research and Development) global fiber-optic test equipment.” We expect EXFO to continue to make strategic investments.

EXFO is in a position make investments and acquisitions. On November 30, 2020, its cash and prepaid expenses came to US$21.923 million. This fell short of its total debt of US$29.539 million. But the net debt of US$7.616 million is only 0.46 times the cash flow of US$16.655 million over the four preceding quarters. This is well within our standard comfort zone of two times or less.

EXFO Inc. remains a buy for further long-term share price gains. But only if you need no dividends.

This is an edited version of an article that was originally published for subscribers in the April 16, 2021, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.

The Investment Reporter, MPL Communications Inc.
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