Some of the world’s largest companies have led the market higher this year, but the most profitable companies are not always the ones with the biggest market cap. Picking highly profitable stocks can lead to substantial gains, and I have found four in the tech sector you don’t want to miss. A recent screen performed by Barron’s showed that picking the most-profitable companies was a winning strategy over the past three years.
Profit margins can reveal how effectively a management team is running a business. It represents what percentage of sales has turned into profits. There are several ways to look at profit margins, such as gross margin, operating margin, and net margin. I prefer net margin, as it shows a company’s bottom line after all other expenses such as taxes have been taken out of revenue. It is calculated by dividing net profits by net sales.
A company could be generating billions in sales, but if those sales don’t result in a profit, then a company is heading in the wrong direction. I ran my own screen to find profitable companies in the tech stock. To get a complete picture of a company’s profit potential, I included three different profitability metrics: net profit margin, return on invested capital (ROIC), and return on equity. That screen resulted in the following four stocks that offer the potential of strong returns based on their profitability metrics: Maxim Integrated Products (MXIM), NVIDIA (NVDA), Arista Networks (ANET), and Aspen Technology (AZPN).
Maxim Integrated Products (MXIM)
MXIM makes high-performance analog and mixed-signal integrated circuits. Unlike other big-name semiconductor stocks that make high profile processors, this company specializes in integrated circuits. These are tiny embedded chips found in consumer electronics and other consumer and industrial products.
While the stock is only up 18.3% for the year, it does offer the potential for future gains as it is poised to benefit from upcoming technologies such as 5G and automotive Internet of Things (IoT). Also, since the company generates revenue from the analog market, this reduces capital equipment costs since analog products’ capacity can be used for more extended periods than digital products.
The company is being acquired by Analog Devices (ADI) for $17 billion, but the deal isn’t expected to finalize until the summer of 2021. In the meantime, MXIM should benefit from strong momentum in driver assistance for electric vehicles and growing demand for 100G laser drivers and modules in the communications and data center market.
MXIM has solid profitability figures with a net margin of 29.9%, an ROIC of 24.2%, and a return on equity of 39.5%. The stock is rated a “Strong Buy” by our POWR Ratings system. It holds a grade of “A” for Trade Grade, Buy & Hold Grade, and Industry Rank. Those are three out of the four components that make up the POWR Ratings. MXIM has a grade of “B” for the fourth component, Peer Grade. The stock is also ranked #19 in the Semiconductor & Wireless Chip industry.
The company is expected to report its latest earnings on October 27th after the market closes.
NVDA is the one stock on this list that is not only highly profitable, but its growth story is highly known as the stock is up 132.7% year to date. The company is the leading designer of graphics processing units that enhance the experience of computing platforms. It has been acquiring companies to advance its own AI capabilities. It completed the acquisition of Mellanox Technologies in April and is looking to close a $40 billion bid for ARM Holdings.
AI seems to be the company’s future as it recently announced that it would be powering the world’s fastest AI supercomputer, based in Europe, and called “Leonardo.” The supercomputer is expected to be involved in drug discovery, space exploration, and weather modeling. The company is also using AI to improve video conferences and reduce dropped calls and frozen screens.
The company is benefiting from the coronavirus-induced work-from-home and learn-at-home trend. It has also gained from strong growth in GeForce desktop and notebook GPUs. Rising demand for its hyper-scale line is boosting the company’s Data Center business. Plus, NVDA’s presence in the autonomous automotive industry should increase with its collaboration with Mercedes-Benz.
NVDA’s profit metrics are holdings strong with a return on equity of 24.4%, a net profit margin of 25.9%, and an ROIC of 21.2%. The stock is rated a “Buy” in our POWR ratings system with a grade of “A” for Trade Grade and Industry Rank, and a “B” for Buy & Hold Grade and Peer Grade. The company is ranked #15 out of 86 stocks in the Semiconductor & Wireless Chip industry.
Arista Networks (ANET)
ANET is a software and hardware provider for the networking solutions sector. Its customer markets include data centers, enterprises, service providers, and campuses. The stock is a play on the growing need of cloud computing. It recently received a boost from JPMorgan analyst Samik Chatterjee, who upgraded the stock from neutral to overweight.
Chatterjee upgraded ANET as he believes the company will benefit from the growth of cloud networking and the growth in the data center switching market. While ANET’s revenue was down 11% year over year last quarter, Chatterjee thinks the company will improve next year due to an upgrade cycle. Cloud companies need to update infrastructure occasionally, and they will be looking to upgrade to 400G technology. ANET management believes that 400G will be a catalyst for its business.
ANET has extended its leadership in open cloud networking software by partnering with Microsoft (MSFT) for open networking for SONIC. It also introduced new cognitive Wi-Fi software that delivers intelligent application identification, automated troubleshooting, and location services. This supports video conferencing applications such as Zoom (ZM), Google Hangouts, and Microsoft Teams.
The company has a very strong profitability profile with an ROIC of 25.1%, a return on equity of 24.8%, and a high net profit margin of 33.2%. The stock is rated a “Buy” in our POWR Ratings system, with a grade of “A” for Trade Grade and a “B” for Peer Grade. ANET is also the #11 ranked stock in the Technology – Communication/Networking industry.
Aspen Technology (AZPN)
The last stock on my list is AZPN, a leading global supplier of software solutions that optimize asset design, operations, and maintenance in complex industrial environments. The company is a dominant force in the software market as it is looking to optimize business problems. It works with enterprise organizations to improve manufacturing and asset management challenges. Its software is used by various companies in industries such as energy, construction, pharmaceutical, and consumer packaged goods.
The company is benefiting from its diversified portfolio, which has held firm amid COVID-induced economic weakness. Current revenue growth is driven by a very high demand for its asset optimization and management solutions. This is due to its solution that aids in optimizing process manufacturing by supporting real-time decision making. It also predicts equipment failure and provides the ability to forecast and simulate potential actions.
Future revenue growth will be driven by the rapid adoption of cloud-based solutions, the proliferation of big data and IoT, and future higher spending on software. AZPN has a strong pipeline for new business bookings, and it continues to innovate and improve operations. AZPN is also considered a wide moat company as its product portfolio and loyal customer base create significant entry barriers.
AZPN has a whopping 60.2% return on equity, an ROIC of 31.2%, and a net profit margin of 39.5%, making this the most profitable technology company, not only in this list but also one of the most profitable stocks in the entire tech sector. The stock is rated a “Buy” with a grade of “A” for Trade Grade, and a grade of “B” for Buy & Hold Grade, Peer Grade, and Industry Rank. The stock is ranked #14 in the Software – Business industry.
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About the Author: David Cohne
David Cohne has 20 years of experience as an investment analyst and writer. Prior to StockNews, David spent eleven years as a Consultant providing outsourced investment research and content to financial services companies, hedge funds, and online publications. David enjoys researching and writing about stocks and the markets. He takes a fundamental quantitative approach in evaluating stocks for readers. More...
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