Here's One World-Beater Nobody Expected

You know the secret formula to make big money in the stock market, right? Look for companies that are small, obscure, and underfollowed, invest before everyone else catches on, and sit back to watch your secret weapon produce vertigo-inducing returns when the secret finally gets out.

Cypress Semiconductor (Nasdaq: CY  ) fits this formula to a T. It's a bona fide small-cap stock (market cap: $1.8 billion today), and you have to be a serious geek to explain what the company actually makes. Is it underfollowed? Well, its five CAPS stars (out of five) rest on 836 member ratings. That may sound like a lot, but compare it to other five-star household names like China Security & Surveillance Technology (NYSE: CSR  ) or Infinera (Nasdaq: INFN  ) , and you'll find that nearly 900 ratings isn't that much after all. Oh, and I was kidding about the "household names" part. Aside from CAPS followers, China Security & Surveillance Technology and Infinera are both underfollowed by the so-called pros on Wall Street as well. At least that group has somewhat caught on to Cypress' heady ambitions.

What's going on?
With definitions out of the way, let's dig into how Cypress is doing these days. That's the exciting part.

Second-quarter sales shot up 43% year-over-year and 10% sequentially to $223 million. See what I mean about "small"? The growth potential is so much greater when you start from a tiny baseline. And we're checking up on Cypress just as the company starts to hit its stride, profit-wise: The year-ago period's $0.32 GAAP loss per share turned into $0.11 of earnings per share, and that's also a 57% improvement over last quarter's $0.07 EPS.

Other newsworthy trends include:

  • Record gross margins, showing pricing power in the open market
  • 85% higher free cash flow -- sequentially, that is
  • Incoming orders are racking up faster than the company can ship 'em, resulting in attractive book-to-bill ratios

Keep this up just a little bit longer, and I don't think Cypress will be a secret anymore. This would be the time to take action, lest you lose out on the initial shock-and-awe value of emerging from the market's shadows.

This is how you do it
OK, so how is Cypress making these impressive strides? Since I am a certified geek, I'll be happy to explain. Cypress designs chips that control and interpret the touchscreens you see popping up on everything from smartphones to dishwashers nowadays.

Many companies large and small have a presence in this market, but only five of them seem to matter: Synaptics (Nasdaq: SYNA  ) basically created the market to begin with, but Cypress and Atmel (Nasdaq: ATML  ) arguably have stronger product lines now and are stealing high-end contracts left and right. Larger competitors Texas Instruments (NYSE: TXN  ) and Broadcom (Nasdaq: BRCM  ) get some nice design wins, too, but are too big and diversified to consider them a play on the touchscreen market.

This is a market that will keep growing for a long time, and where quality products tend to get proportionally more business than run-of-the-mill solutions. Cypress does not have a monopoly on the sector, but it is a well-respected competitor with a healthy slice of the growing pie. And like I said, the general market hasn't caught on to this stock yet.

What's next?
A price-to-earnings ratio of more than 170 may seem scary, but you have to remember that this company is just now emerging from a trailing sea of red ink. Before today, there were no earnings to measure against. This stock trades for about 12 times forward earnings and is expected to grow profits by 14% a year for the foreseeable future. Cypress also added Akamai Systems CFO J.D. Sherman to its board a couple of months ago, and I expect that move to bring fiscal stability along with industry-relevant business expertise. This is just the beginning for Cypress.

I'm heading over to CAPS to give Cypress a solid thumbs-up rating. In a couple of quarters, when this growth story is exposed by the conspicuous profits racking up, this pick will boost my all-star CAPS status. Follow me and get the same winning treatment.

Fool contributor Anders Bylund holds no position in any of the companies discussed here. Akamai Technologies, Cypress Semiconductor, and Infinera are Motley Fool Rule Breakers picks. The Fool owns shares of Infinera. Try any of our Foolish newsletters today, free for 30 days. You can check out Anders' holdings and a concise bio if you like, and The Motley Fool is investors writing for investors.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 23, 2010, at 2:21 PM, Zfisherofmen wrote:

    Anders - You are right on. CY re-made it's self recently. 2002 - 2010 From the old memory silicon factory (which is still a flagship product - Static Ram) it just about owns that market; To the Microcontroller market. This is where the touch screen comes in and that is just the beginning, touch Screen is an emerging market but so is the base technology that is comes from PSoC. Programmable System on a Chip. Once the world catches on that they can replace their Million $ ASIC with a $5 to $15 chip watch out with time to market cut in Half. This company will be flying high!

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