Broadly speaking, technology companies had one of their best years ever in 2021. But historical stock market returns suggest 2022 is unlikely to be as strong as last year, and that means investors need to focus more on the quality of their stock selection.
Picking winners is difficult especially when it comes to technology stocks, because part of the analysis involves making assumptions about what the future might look like, as opposed to simply assessing a business on its own merits. But three Motley Fool contributors think Cohu (COHU -1.47%), Confluent (CFLT -0.53%), and Axon Enterprise (AXON -2.41%) are set to stand out from the broader market this year, and they can be picked up right now.
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Driving the semiconductor industry
Anthony Di Pizio (Cohu): The semiconductor sector was a reliable performer in 2021, with the iShares Semiconductor ETF crushing the overall return of the technology-centric Nasdaq 100 market index. But as we progress through 2022, the most interesting opportunities in this industry might be in the small, specialized service providers rather than the popular manufacturers.
Cohu has a market capitalization of just $1.7 billion, and it supplies testing and handling equipment to the world's largest semiconductor producers. It's key to the inspection process, completing defect detection on some of the industry's smallest chips, which power crucial digital features in new cars, for example. With the automotive sector arguably the hardest hit by semiconductor shortages in 2021, Cohu shifted its focus to that segment to help alleviate supply pressures, and it now represents 20% of the company's total revenue.
The best operating environment for Cohu is one where semiconductor manufacturers rapidly expand their production capacity, which drives demand for the company's equipment. Pandemic years 2020 and 2021 certainly fit the bill, and some of the world's largest automotive companies predict they'll continue to face chip shortages in 2022.
That places Cohu in a great position this year, and analysts predict the company will deliver $2.95 in earnings per share. It's comparable to the $3.01 result in 2021 (pending its official fourth-quarter result), which was Cohu's first profitable year since 2017. But importantly for investors, it places the company's stock at an incredibly cheap price-to-earnings multiple of just 11. That's about 65% cheaper than Cohu's peers represented by the iShares Semiconductor ETF, which trades at a multiple of 33.
Cohu's breakout year was definitely 2021 from an operational perspective, but look for some follow-through in 2022.
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A mission-critical service
Jamie Louko (Confluent): When it comes to businesses that could break out and see major growth over the coming years, there is perhaps no other company that could see stronger growth than a market leader in an industry that will nearly double in the coming years. If you like the sound of that, you might want to look at Confluent. Confluent is helping businesses analyze data in motion by managing a notoriously difficult and hard-to-scale open-source project for businesses.
Apache Kafka allows businesses to analyze data in real time, which is incredibly important for almost any business. Eighty percent of the Fortune 100 use Kafka in some part of their business, but Kafka is extremely hard to scale up in an entire enterprise. Confluent works as a Kafka manager, scaling and managing the open-source platform to be used across an entire business.
What makes Confluent the standout leader in the space is that its founders were the same developers who created Kafka, so nobody else in the industry knows Kafka better than Confluent. When dealing with core services like Kafka, a business would want to have the best managers in the industry, making Confluent the top pick. This has resulted in stellar financial performance for the company. Since the fourth quarter of 2019, the company has sequentially grown its revenue and in the third quarter of 2021, Confluent grew its top line 67% year over year to $103 million.
The company is spending a lot now so that it can capture the growth ahead. Confluent spent $47.7 million in research and development expenses and almost $87 million in sales and marketing in Q3 in hopes that it can obtain more market share in its fast-growing industry. By 2024, Confluent expects that its opportunity will almost double to $91 billion. With its leadership team and impressive spending to succeed in this market, I believe that Confluent could see major success over the coming years as its industry grows.
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Making law enforcement more efficient
Trevor Jennewine (Axon Enterprise): Axon's mission is to protect life. Formerly known as Taser International, the company is still the leading global manufacturer of conducted electrical devices (i.e., Tasers). But in recent years, Axon's portfolio has expanded to include an ecosystem of connected sensors (e.g., body-worn cameras, dash cameras, drone-mounted aerial cameras) and cloud-based software.
Here's how it works: Axon sensors feed video data to Axon Evidence, a cloud-based repository that improves law enforcement efficiency by simplifying evidence storage. Similarly, Axon Records uses video evidence and artificial intelligence to streamline the report writing process, reducing the time officers spend on administrative tasks. Additionally, Axon sensors feed information to Axon Respond, real-time operational awareness software that helps dispatchers, first responders, and law enforcement officers collaborate, monitor action in the field, and make data-driven decisions.
Why invest in Axon? Due to its early success in the Taser industry, the company has relationships with 94% of law enforcement agencies in the U.S. Axon has leveraged those relationships to establish itself as the market leader in body-worn cameras and software. And that has translated into an impressive financial performance over the past year.
Axon's sales surged 39% to $872 million, gross margin expanded 410 basis points to 62.8%, and software revenue retention came in at 119%, implying a 19% uptick in average spend per customer. Axon is still unprofitable under generally accepted accounting principles (GAAP), as it posted a loss of $21 million over the past 12 months. But the company generated positive free cash flow of $103 million, evidencing the sustainability of its business model.
Axon still has plenty of room to grow. Management recently revised its addressable market to $52 billion, up from $27 billion. The updated figure highlights Axon's potential in two new markets: consumer safety and justice software. And the company is already executing on that opportunity. In December, Axon introduced Attorney Premier, the first digital evidence system for prosecutors and defense attorneys. The platform streamlines workflow for legal teams, helping clients organize, review, and share evidence more efficiently.
Shareholders should expect great things from Axon in the years ahead. That's why this breakout growth stock looks like a smart buy right now.
