The Best Small Cap for 2007: FormFactor

At first glance, FormFactor (Nasdaq: FORM  ) , the worldwide leader of semiconductor wafer probe cards, might reek of extremely complex technology that can only be understood by the members of your local Geek Squad. That's what I first thought when I read the acronyms NAND, NOR, and DDRII in their 10-K filing, after it was formally recommended by our team over at the Hidden Gems newsletter service.

But if you look closely, FormFactor's business model is actually pretty straightforward. It even makes for a pretty attractive investment idea, too; so enticing, in fact, that it gets my hands-down vote for best small-cap stock of 2007. Let's see whether you agree.

Chips or crackers?
There's little doubt that you've heard of microchip-making giants like Intel (Nasdaq: INTC  ) and Samsung before. But the company that actually enables these chip manufacturers to test their devices -- prior to being cut into individual chips -- is a firm you probably haven't heard of. This type of microchip testing is exactly what FormFactor does, and it does it very, very well. FormFactor's wafer probe cards (the doohickeys on which the devices are tested) dominate the field in convincing fashion, hoarding approximately 70% of the market.

Going forward, it looks as though this relatively small company, valued at $1.74 billion, will only extend its lead and probably grow up to be a major-league "big cap" someday (every proud, small-cap parent's dream come true). Of course, the Foolish question is, why?

Well, the answer is really pretty simple. FormFactor's patented MicroSpring technology is truly state-of-the-art, and it's revolutionized the way business is conducted in the probe card industry. I know what you're thinking -- you hear this kind of "groundbreaking" talk about a lot out of smallish, techie-type companies, right? But FormFactor really is different, and it has the facts to back it up.

Always in good form
FormFactor's products are important to their impressive roster of clients such as SpiroxCorporation, ElpidaMemory, and the previously mentioned Intel and Samsung for one main reason -- they save money. FormFactor's unique technology essentially creates cost-effective solutions for their customers that competitors like Advantest (NYSE: ATE  ) and Cascade Microtech (Nasdaq: CSCD  ) simply can't match. To illustrate, FormFactor's wafers can test more than 250 devices at one time, while the average probe card can only test about 60.

This advantage translates into rock-solid financials for FormFactor; the company sports operating margins of 20%, revenue growth of more than 50% in the most recent quarter, and an immaculate balance sheet with zero debt. With that kind of "large moat" technology and financial performance, FormFactor is a big small-cap story worth watching.

But if you're still unconvinced, may I recommend you read the analysis that fellow Fools Richard Duprey and Tom Engle wrote on the company back in 2004? Much of their investment thesis has played out exactly as forecasted: FormFactor's domination in the dynamic random-access memory (DRAM) market, its expansion in other segments such as flash memory and chip logic, and a price target of at least $36 per share by mid-2007.

As I write today, shares of FormFactor are a touch above $37 and the stock is up 79% since they picked it (versus an S&P return of 25%). Those Hidden Gems guys are scary, aren't they? Yup, but it really just goes to show you the value of choosing a top dog, best-of-breed company -- especially when it's still a little pup with tons of room left to grow.

Care to make a wafer?
So, there you have it, my fellow Fools. If you also think that FormFactor's got all of the right factors in place to become 2007's best small-cap stock, let us know in our Motley Fool CAPS community. Simply give FormFactor an outperform rating. Of course, if you disagree with my assessment, then feel free to hand it an underperform rating (no hard feelings!). Based on your votes and opinions, we'll declare the best small-cap stock for 2007 early next week . so stay tuned. To make your voice heard loud and clear, sign up for the free service here.

Seen our other contenders for best small cap? If not, click here.

Intel is an Inside Value selection.

Fool contributor Brian Pacampara enjoys his wafers with a cup of tea, but holds no position in any of the companies mentioned. The Fool's disclosure policy is always tried, tested, and true.


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