Profit From Small-Cap IT Stocks -- the Easy Way

Profit From Small-Cap IT Stocks -- the Easy Way

Exchange-traded funds offer a convenient way to invest in sectors or niches that interest you. If you'd like to add some small-cap IT stocks to your portfolio but don't have the time or expertise to hand-pick a few, the PowerShares S&P SmallCap Information Technology ETF could save you a lot of trouble. Instead of trying to figure out which companies will perform best, you can use this ETF to invest in lots of them simultaneously.

The Basics
ETFs often sport lower expense ratios than their mutual fund cousins. This ETF, focused on small-cap IT stocks, sports a low expense ratio -- an annual fee -- of 0.29%. The fund is fairly small, too, so if you're thinking of buying, beware of possibly large spreads between its bid and ask prices. Consider using a limit order if you want to buy in.

This ETF has performed well, topping the world market over the past three years. As with most investments, of course, we can't expect outstanding performances in every quarter or year. Investors with conviction need to wait for their holdings to deliver.

Why small-cap IT stocks?
Small-cap stocks deserve a place in your portfolio for their growth potential. After all, any huge, successful company once began as a small one. They don't all make it, though, so investing via an ETF that bundles many together can deliver welcome diversification. Meanwhile, the information technology (IT) field is especially promising, given the ongoing spread of technology.

More than a handful of small-cap IT stocks had strong performances over the past year. Machine vision leader Cognex surged 82%, driven in part by a strong second-quarter report. It featured revenue up 3% and EPS down 16% due to investments in new products and sales channels, along with management raising projections. (Cognex reports its third-quarter results on October 28.)

Maximus popped by 65%. This small-cap IT stock offers consulting and outsourced services to governments, and is profiting from Obamacare, too. For example, its work supported the successful Minnesota health-care exchange. In its third quarter, revenue grew by 26%, EPS jumped 32%, and new orders totaled $413 million. It offers a dividend that's growing, albeit one that only yields 0.4% at the moment.

Arris Group gained 33% and is more than just a company with a ticker symbol that suggests pirate-talk. It acquired Motorola Home and is in the business of offering video and broadband technology to cable system operators. It's poised to benefit from growth in fiber optics. Analysts at Zacks upgraded the company to outperform in September, expecting strong demand and growth, but then downgraded it to neutral on a valuation basis, citing some risks such as cable companies losing business. Arris's third quarter featured revenue tripling and earnings trouncing expectations.

Other companies didn't do quite so well over the last year but could see their fortunes change in years to come. Audio chip maker Cirrus Logic shed 38%, in part as a result of disappointing quarterly results and guidance. Its dependence on Apple is a concern to some analysts, as Apple accounted for more than three-quarters of revenue in its last fiscal year, though Cirrus has been lining up other customers. They also fear that lower-priced iPhones could hurt Cirrus and think its growth is due to slow. Bulls have seen its problems as short-term, though. Its return on equity has grown in recent years, topping 28%, while net margins are also solid at 17%. Free cash flow has been growing, too.

The big picture
Consider adding small-cap IT stocks to your portfolio. A well-chosen ETF can grant you instant diversification across any industry or group of companies and make investing in it -- and profiting from it -- that much easier.

Editor's note: A previous version of this article used out-of-date information on Cognex's dividend. The author and the Fool regret the error.

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Longtime Fool contributor Selena Maranjian, whom you can follow on Twitter, owns shares of Apple. The Motley Fool recommends Apple and Cognex. The Motley Fool owns shares of Apple and Cirrus Logic. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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