When I added shares of Sierra Wireless Inc. to my Strategy Lab model portfolio, I did so because of the small cap company’s exposure to what we now call “The Internet of Things.” The Richmond, B.C.-based company exhibited, and still exhibits, the right combination of great management, leadership in its industry and big potential growth. Those are the kinds of investments I like to tuck away in my portfolio for a long time to come.
So far, my bet on Sierra Wireless has turned out to be correct. When we started Strategy Lab in September, 2012, the shares traded at $8.67 (U.S.). Today, as I write this, the stock is at about $28 allowing me to show a gain of well over 200 per cent. It’s no Netflix (more than a 700 per cent gain), but I’ll take it. For a trade that is coming up on its second anniversary, I have no complaints.
Quite a few people seem to be wondering if the stock is still worth holding. With such a huge run in price isn’t it getting expensive? After all, the stock is at a record high for the past decade.
Anyone who follows my way of thinking about stocks already knows the answer to this question. I’m not afraid to hold onto stocks that are hitting new highs. Yes, they sometimes come crashing down. But the simple truth of the matter is you can’t get enormous returns without holding onto stocks that are constantly reaching new highs. If you let yourself get freaked out because of the psychology of price anchoring (comparing today’s price to some past price), you’ll never be able to settle into the mindset of a long term investor.
I still very much like Sierra Wireless today. They are the biggest vendor of cellular modems for use in things such as cars, payment terminals, digital billboards, Internet routers, home alarms and many other vertical markets where cellular connectivity needs to be embedded in a product. For example, Philips just teamed up with Sierra to offer municipalities a way to monitor and control streetlights via wireless connections to each light. New applications like this are bound to keep popping up over the next decade. In many cases, Sierra is also pushing its own services platform so customers can manage and control their infrastructure without having to build something from scratch. The upside for Sierra Wireless is higher-margin recurring revenue.
Last quarter revenue was $135-million, which represents organic growth of about 17 per cent. Adjusted earnings per share was eight cents. That’s not enough profit to support a $28 stock price. But I expect they can ramp up revenue without having to spend a lot more on operating expenses. In other words, there is a lot of leverage in their business model. Next quarter, the company expects to grow revenue to perhaps $140-million, yet earnings should grow to as much as 15 cents a share. A quick run-rate calculation on this (60 cents a year) tells me that the stock price reflects about 48 times this level of earnings.
That probably sounds expensive to many readers. But I’m looking for another double in the next five years. In that time, I think Sierra Wireless can grow to $1-billion in revenue and achieve a 10-per-cent operating margin. After tax, that should lead to more than $2 in earnings per share assuming some share dilution. If the company still has a reasonable growth rate at that time, I’d expect the stock to trade at more than $50 a share. So I’m not expecting another 200 per cent gain in two years, but I do think it’s a market-beating stock over the next five years.
The author owns Sierra Wireless in both in his Strategy Lab and personal portfolios.