Tech trio: Investing in 'Killer Apps'

"We believe that the recent relative strength of tech stocks is the start of a longer term trend,  not merely a flash in the pan," says Jim Oberweis and Dave Covas.

In The Oberweis Report, they explain, "Our confidence stems from the emergence of the next Killer Apps, which drive technology cycles because they change how we live our lives." Here, they make a case for technology and offer a trio of small cap favorites.

"During the 1980’s and early 1990’s, the personal computer was the Killer App. During the late 1990’s, it was the Internet. During this decade – zilch.

" Until now.  The next Killer Apps – video-on-demand and ubiquitous high-speed wireless connectivity – are coming. 

"During the next 10 years, video-ondemand will change how we watch TV and see movies.  Soon enough, you will be able to watch what you want, when you want. Say adios to the traditional TV networks, and maybe even to your cable TV provider.

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And 'smart phones' cruising high-speed wireless networks will morph from boring and blasé cell phones into robust, multi-functional devices. Apple’s iPhone, after all, is really a mini-computer that just happens to have phone capabilities.

"Frankly, the product’s name doesn’t do it justice. Just as Apple’s unique graphical user interface in the original Macintosh accelerated the proliferation of computers, their revolutionary iPhone marks the start of the real smart phone revolution.

"So assuming a more favorable technology backdrop, how should investors evaluate potential technology investments?  There are winners and losers in every tech cycle, and the technology business can be tricky and fast-moving. Some basic tips: 

• • Try to identify technology stocks levered to Killer Apps and avoid slow-growth parts of the technology industry. Target companies tied to smart phones and video-on-demand. Avoid stocks that depend on the PC market, which is now a mature, slow-growth industry. 
• • Look at a company’s revenue growth rates. Are sales growing rapidly and accelerating?  Do consumers thirst for more of what the company makes? 
• • Target proprietary products and avoid companies that make commodity-type products. If you lack a degree in computer science or electrical engineering, a good way to do this is to examine a company’s gross profit margin on their income statement. High gross margins north of 40% signal that a company makes something relatively unique – at least for now. 

"Low gross margins imply that products are 'me-too' and that the primary method of competition is based on price. Even better, look at gross margins over the past few years to see if they are expanding. Contracting gross margins are a red flag that competition is heating up. 

"Some ways to play a stronger technology market: 

"Synaptics (NASDAQ: SYNA) makes touchpads and touchscreens for PC’s and smart phones that allow users to control their devices.

"Although Synaptics’ touch screens are not used by Apple, the com-pany has secured design wins for competing smart phones from RIMM, Nokia, and LG. The company grew revenues 28% year-over-year last quarter and had 42% gross margins.

"Starent Networks (NASDAQ: STAR) manufactures wireless infrastructure equipment used by cell phone providers to deliver high-speed functionality to their customers.

"Starent’s equipment is the backbone that helps wireless networks operate at broadband speeds. The company grew revenues 30% year-over-year last quarter and had 80% gross margins.

"Netlogic Microsystems (NASDAQ: NETL) designs 'knowledge-based' processors that allow network providers to prioritize network traffic, slowing down low priority traffic like emails and accelerating delivery of high-priority traffic like streaming video.

"Network optimization helps make video-on-demand a reality. The company saw revenues contract last quarter because of the slumping economy but had 69% gross margins. Revenue growth should re-accelerate in the coming quarters.

"As the market emerges from the bear market – which was driven by a commodities and housing bubble – expect market leadership to rotate. We believe technology stocks could be poised to once again lead the way."