Technology moves pretty fast. Companies come and go, and if you know what you're doing, you might be able to flag the right ones to make a bit of scratch. Good small cap tech stocks are even tougher to find. These little buggers can wipe out your portfolio quicker than a hiccup.
But there is another way to play this lucrative space. Despite their size, some small cap tech businesses generate enough cash to pay out a generous dividend. Companies like Silicom (NASDAQ:SILC), Magic Software (NASDAQ:MGIC), and Silicon Motion (NASDAQ:SIMO) may be small, but they're no joke. Not only are these companies growing in leaps and bounds, but they're profitable enough to kick you some love for believing in them.
I'm drawn to these companies because the dividend generally validates their business models. To me, it feels like management knows it has a good thing, it doesn't need the excess cash, and it's thanking you for being a partner. And we're collecting that dividend while we wait for these million-dollar companies to become billion-dollar companies.
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The Hidden Gem
Silicom is a device maker that works closely with a bunch of big-name OEMs like Intel and Cisco. It does business in the cloud, security, virtualization and big data markets. Obviously, these are good places to be and Silicom has never lost a customer.
One of its core devices is called a server to appliance converter, or SETAC. SETAC works because it takes an existing server and changes it so you can connect to the front of the machine. Before SETAC, you could only get this flexibility from hardware of lesser quality.
Recently, Silicom developed a SmartSilc VHIO, which is a virtualization offloading product that takes some of the burden off a CPU. This matters because if OEMs can ease up on the amount of stuff running off and through their CPU, they will be able to save power, money, and use their CPU for other things. What I like best about Silicom is its ability to spot trends. When management figures something out, it then tasks their engineers (who often work with their customers) to build something relevant.
Despite its small size, Magic Software is an enterprise solutions designer, with 30 years of experience, and does business in over 50 countries. It also owns an impressive customer portfolio with heavyweights like; Microsoft, Salesforce.com, Oracle, and IBM. But what really stands out, is that it draws on these partnerships to develop and improve its product offerings. This reminds me of Silicom, where it connects its engineers to engineers at other companies, to create mutually beneficial solutions.
Ultimately, Magic Software allows companies of all sizes to seamlessly and easily use data to improve their operations. Earlier this month, the Boston Medical Center equipped its techs with Apps that run Magic's end to end mobility solution. From Bob Biggio the Vice President of Facilities and Support Services for Boston Medical Center, "Magic's enterprise mobility solution enabled us to develop and deploy our mobile apps quickly and successfully, much faster and with lower risk than with any competitive solution."
Silicon Motion is a fabless semiconductor company, which means it develops, markets, and designs its stuff, then it has a partner (think foundry) make the devices. This works for many semiconductor companies because it allows them to divert resources to creating devices, without spending time and money to mass produce them.
Silicon Motion's two major product categories are its mobile storage and mobile communications units. The mobile storage unit is comprised of microcontrollers that focus on NAND flash memory products, while its communications segment has to do with RF transceivers for cellular devices.
Earlier this month, management announced that its SS2246EN controller supports Micron Technology's 16nm, 128Gb MLC NAND flash. From Paul Peterson, director of marketing for Micron's NAND component division, "We're pleased to work closely with Silicon Motion's expert controller developers to enable a compelling storage solution for high capacity, high-performance and power efficient devices..."
The fly in the soup
While this all sounds great, there are risks you should be aware of. Obviously, a 3% to 4% dividend will not protect you if the company stumbles and the stock takes a 50% hit. Small cap tech companies are still figuring it out, so bad things can and will happen. If you read through the risk factors of any companies 10-K, you'll be surprised by what could go wrong.
One way to eliminate company specific risk is to diversify, I like to call it buying a basket. When you buy a basket, you're looking to add a bunch of high quality businesses to your portfolio. From the book Investment Analysis and Portfolio Management, Reilly and Brown found that if you can get your portfolio to 12-18 stocks, you will have achieved around 90% of the "benefit of diversification". This means the poor performance of just one company won't wipe you out.
Foolish final words
As you can see, these small cap tech dividend payers have throttled the market over the past five years. Clearly, this is a fertile hunting ground. The trick is to avoid the duds and find the Hidden Gems.
If you've invested in Silicom, Silicon Motion, or Magic Software, you're probably sitting on some serious outperformance. The question is: do these businesses have enough lasting power to duplicate their past results? I think so, but you should do your work on these companies before adding them to your basket.
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Wade Michels owns Silicom Ltd. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.