There's been a big rally in tech stocks this year, led by those companies involved in the current generative artificial intelligence (AI) buzz. However, the overall market is still waiting for the start of a new bull run and the economy is working to absorb the effects of the U.S. Federal Reserve's interest rate hikes. The S&P 400 (a mid-cap stock index) and the Russell 2000 (a small-cap index) have barely budged over the last 12-month stretch after getting hit hard in 2022.
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Three smaller and underfollowed tech stocks had an especially bad run during this time. But all three could still have a very promising future for investors willing to show some patience. Here's why.
1. Ubiquiti: A stock few have the courage to follow
Robert Pera is having a rough 2023. Not only is the NBA team he's owned since 2012 (the Memphis Grizzlies) starting off the 2023-24 season in less than tip-top shape, but his company Ubiquiti (UI 0.44%) saw its stock price plunge by more than 50% so far in 2023.
Pera, who is founder, CEO, and chairman of Ubiquiti, probably cares a lot about that. He owns over 93% of all outstanding shares of the company.
There's an ongoing downturn in enterprise hardware sales this year, as many companies have been in cash conservation mode. Consumer electronics, including networking, smart home, security, and related office equipment, are also down. After booming sales during the pandemic's height, there's still an overhang of excess inventory that needs to be worked through.
Ubiquiti is sitting on a great deal of excess inventory itself. Revenue remained relatively stable (down 7% year over year in first-quarter fiscal 2024 (ended in September 2023)), but the resulting free cash flow was hit hard. Sales to enterprise and network service provider customers have gone cold lately, contributing to the sudden jump in inventory and resulting drop in profitability.
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That's the likely reason the market soured on Ubiquiti stock. It doesn't help that Pera and his company stopped hosting quarterly conference calls years ago to explain their efforts to beat these headwinds. Ubiquiti also hasn't made any stock repurchases since early in 2022, instead just doling out its quarterly dividend (currently yielding 2.1% a year). These things may also have the market fleeing Ubiquiti stock.
Ubiquiti has a solid track record of profitable growth since its 2011 IPO, though. And with investors scratching their heads about the network hardware company, now might be a buying opportunity. Shares trade for 18 times trailing 12-month earnings per share, perhaps the best value for the stock in years.
I've toyed with the idea of starting a small position in Ubiquiti in the past, but this time I might actually bite on hopes of an eventual uptick in demand for its networking and security hardware.
2. Shift4 Payments: Betting on a best-in-class hospitality payments push internationally
Shift4 Payments (FOUR 0.22%) is a small but fast-growing digital payments acceptance provider. It got its start with its point-of-sale solutions for in-person transactions, especially for the hospitality industry. It's been over two decades since founder and CEO Jared Isaacman started Shift4, and its core customers -- hotels, restaurants, and other small merchants and businesses -- continue growing at a stable pace.
In fact, since the IPO in 2020, Shift4's trailing 12-month revenue has grown from less than $1 billion to nearly $2.4 billion over the last reported one-year stretch. That includes during the early days of the pandemic, when much of the company's core customer base wasn't allowed to conduct in-person business.
In recent years, Shift4 has expanded in new directions, including extending its payments network to encompass online (physical card not present) transactions. Customers have been getting bigger too, including sports and entertainment venues for the NBA and NFL.
The next big push, though, will be international. Shift4 just completed the acquisition of a small company called Finaro, which already has a foothold in Europe. Shift4 expects that its low-cost point-of-sale system and behind-the-scenes payment acceptance network will help it replicate its success in the U.S.
Shift4 is tiny compared to large peers like PayPal and Block, but it's profitable, and profit margins are expanding rapidly.
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After a rollercoaster ride since it became a public concern, this could be a top small-cap payments stock to own for the years ahead, especially if a new bull market finally gets rolling for this beaten-down part of the stock market. I made a purchase this past summer and may add more to my portfolio soon.
3. SkyWater Technology: A tiny specialty chip fab making great progress
In a world where semiconductors are increasingly important, investor attention tends to skew heavily toward chip manufacturing giants like Taiwan Semiconductor Manufacturing, Samsung, and Intel. But one tiny chip fab (a facility that makes silicon wafers, which get cut into "chips" and packaged into an electronic system) thinks there's room to go after a smaller niche.
SkyWater Technology (SKYT 5.30%) started out as a spinoff from Cypress Semiconductor (now part of Germany's big chipmaker Infineon) in 2017. SkyWater makes the bulk of its money from a contract with the U.S. Department of Defense, but it has been picking up steam by signing development partnerships with start-ups and other companies that need specialty semiconductor tech.
I'll stress that SkyWater is a tiny operation, and there's added risk that comes with investing in such a business. Revenue increased 37% year over year in the third quarter of 2023, bringing its quarterly sales total to just $71.6 million. As you might expect for a fab this small, SkyWater isn't profitable -- at least not yet. GAAP net losses were $7.6 million in Q3, largely due to start-up costs in its fab as manufacturing activity begins picking up pace again.
One potentially positive development for SkyWater's continual growth and long-term progress toward profitability, though, was the announcement that chip design software giant Cadence Design Systems now offers SkyWater development kits to its customers. That could drive interest in SkyWater's small fab.
At any rate, bear in mind this is by far the riskiest of the three stocks on this small- and mid-cap stock list. SkyWater has a lot to prove, and it will be highly reliant on picking up new clients and helping existing ones ramp up chip production for their largely experimental projects. And with a market cap of just $320 million as of this writing, there's plenty of risk that this company will get squashed by the immense size of its peers.
SkyWater has shown me enough promise that I've taken a very small initial position, one that I might add to if it continues to make positive progress. Other top chip stocks remain by far my primary bets on computing technology, but SkyWater nevertheless could have an off-chance of producing outsized growth in the future.
