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4 Safe Small-Cap Tech Stocks to Play Brexit

Zacks Equity Research

Following Britain’s vote to leave the European Union (EU), markets across the world have grown restive. In this situation, large- to mid-cap technology stocks having exposure to the European market have suffered immensely, as investors feared these firms will be up against regulatory overhangs, currency fluctuations and skill shortage.

But, most small caps from the sector are unperturbed, thanks to their minimal exposure to the global economy. Hence, it will be prudent to invest in such fundamentally solid small-cap tech stocks for enticing returns. We have also selected such stocks that have a low beta, which keep them immune to Brexit induced market volatility. Also, demand for technology and innovation is always at a high, which will help technology stocks to report above par earnings than stocks from other sectors.

Brexit Sparks Volatility, Weighs on U.S. Stocks

Defying expectations, British voters decided to leave the EU on Thursday, a stunning development indeed as it is the first country to do so in the bloc’s 59-year history. The outcome went against the prediction of the U.K. bookmakers who were pointing to a win for those willing to stay in the EU.

U.S. stocks tanked on Friday after investors feared that such an outcome will destabilize the region’s economy, slow down global growth and create fresh bouts of volatility in the financial markets worldwide. The S&P 500 and the Dow wiped out year-to-date gains and were off more than 3% at the end of Friday’s session, while the fear-gauge CBOE Volatility Index (VIX) jumped to its highest percentage rise since Aug 8, 2011 (read: Brexit Wins, But at what Cost to British Firms?).

Tech Behemoths Reel on Brexit Vote

Needless to say, tech stocks weren’t spared either, with the tech-heavy Nasdaq plunging 202.06 points or 4.1% to end at 4,707.98 during the last trading session, its worst one-day percentage decline since Aug 2011. Almost all the major tech companies in Silicon Valley weren’t able to dodge the bloodbath. Cupertino-based Apple Inc. AAPL, Mountain View-based Alphabet Inc. GOOGL and Menlo Park-based Facebook, Inc. FB slumped 2.8%, 4.2% and 2.6%, respectively, on Friday.

The newly listed Twilio, Inc.’s TWLO stock plummeted 8.27% to $26.30 a share on Friday. The online lending company, LendingClub Corporation (LC), which is already suffering from an executive shakeup, saw its shares tank 5.8% to $4.69 per share. Digital wallet and payment service firm PayPal Holdings, Inc. PYPL too fell 4.3% to $35.08 per share (read: Brexit hits U.S. tech stocks: Alphabet, Apple, HP, IBM, Intel, Microsoft, PayPal, Twilio fall).

Computer and Technology Sector Price Index

Computer and Technology Sector Price Index

What Brexit Means for Tech Companies?

U.S. majors such as Microsoft Corporation MSFT campaigned against a Brexit. They believed U.K. remaining a part of the EU was a major reason for investments. Such a membership was the guiding force behind Microsoft’s first overseas R&D laboratory in Cambridge. Thanks to Brexit, there is a lot of uncertainty now about the future of the company’s operation in the U.K. (read: Microsoft’s perspective on the EU referendum).

The fate of the U.S. and EU’s data flow and privacy agreement, which was in its final adjustment phase, is also in jeopardy. With one of the major players in the EU backing out of the coalition, doubts arise as to what will happen to data flowing in and out Britain to the rest of the world. 

More alarmingly, the British pound experienced one of its most tumultuous sessions on Friday, declining to its lowest level since 1985. Such currency fluctuations are expected to take a toll on the technology sector in the upcoming quarters. Companies such as Apple will have to increase their product price in the U.K. in order to maintain its value. On the other hand, Britons will be less inclined to buy such products as the economy takes a downturn.

Global tech firms including U.S. firms have their offices in Britain. But, a Brexit will harm these tech firm’s ability to acquire skilled workers. Without the EU’s permission to let workers move freely between countries, having qualified workers will become a serious issue, which in turn will adversely affect the growth of such companies.

Buy 4 Ultra-Safe Small-Cap Tech Stocks Now

Amid all these uncertainties and concerns plaguing the broader technology sector due to U.K. leaving the EU, small-cap firms from the aforementioned sector are comparatively insulated from the fall-out. This is because such firms derive a far greater percentage of their revenues from domestic sources than larger companies. Small caps also have far less exposure to the global economy.

Moreover, concerns such as Brexit won’t bother small-cap stocks, as over the last one year such firms have not only focused on growth but also increased their value, a move that will help them generate steady earnings in the near future.

We have selected four fundamentally solid small-cap tech stocks that boast a Zacks Rank #1 (Strong Buy) or Zacks Rank #2 (Buy). Additionally, we have narrowed down our search with a VGM score of ‘A’ or ‘B.’ Here V stands for Value, G for Growth and M for Momentum and the score is a weighted combination of these three scores. Such a score allows you to eliminate the negative aspects of stocks and select winners.

In the immediate term, there are also a lot of gyrations in the market. To negate such volatility, we have selected such small-cap tech stocks that have low beta. Such stocks have a beta of less than 1 suggesting that the price movement of these stocks is not overly correlated with the market. Since they are less volatile than the market they are also less risky.

ARI Network Services Inc. ARIS provides software-as-a-service and data-as-a-service solutions to equipment manufacturers, distributors and dealers. ARIS has a Zacks Rank #2 and a VGM score of ‘A’. ARIS has a beta of 0.06 and the company’s expected earnings growth for the current year is 35.7%.

Varonis Systems, Inc. VRNS provides software platform for enterprises to analyze, secure, manage and utilize their unstructured data. VRNS has a Zacks Rank #2 and a VGM score of ‘B’. VRNS has a beta of 0.78 and the company’s expected earnings growth for the current year is 4.4%.

Badger Meter Inc. BMI manufactures and sells flow measurement and control technologies related products. BMI has a Zacks Rank #2 and a VGM score of ‘B’. VRNS has a beta of 0.82 and the company’s expected earnings growth for the current year is 31%.

UTStarcom Holdings Corp. UTSI operates as a telecom infrastructure provider to develop technology for bandwidth from cloud-based services. UTSI has a Zacks Rank #2 and a VGM score of ‘B’. UTSI has a beta of 0.9 and the company’s expected earnings growth for the current year is 77.4%.

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