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Is Data I/O Corp (DAIO) A Great Investment Choice?

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New York-based Long Cast Advisers LLC, a boutique investment management firm, published its first-quarter 2021 investor letter – a copy of which can be downloaded here. Cumulative returns on accounts managed by Long Cast Advisers improved 30%, net of applicable fees, ahead of the baseline (S&P Total Return index, iShares MicroCap ETF and the Russell 2000 index). You can view the fund’s top 5 holdings to have a peek at their top bets for 2021.

Long Cast Advisers, in its Q1 2021 investor letter, mentioned Data I/O Corporation (NASDAQ: DAIO), and shared their insights on the company. Data I/O Corporation is a Redmond, Washington-based programming and automated device handling systems manufacturer that currently has a $ 50.9 billion market capitalization. Since the beginning of the year, DAIO delivered a 46.84% return, extending its 12-month gains to 100.33%. As of May 28, 2021, the stock closed at $5.86 per share.

Here is what Long Cast Advisers has to say about Data I/O Corporation in its Q1 2021 investor letter:

"DAIO is a $30M EV manufacturer of automated programming machines that batch program microchips. Given the pervasiveness of chips in manufactured products, these machines are “modern shop tools”. They cost ~$250k to ~$750k per unit. Chips programmed on their machines end up in everything from e-cigs to medical devices to IoT connected appliances. DAIO’s high end machines (the “PSV family”) have a throughput of ~2,000 chips / hour – comparable to competitors Dediprog, Xeltek and BPM to name a few – and overall the company has an installed base of ~340 units. Ostensibly, run around the clock (impossible, but just for the sake of this hypothetical), their machines could program more than 5B chips year, which is less than 1% of the total chips produced every year.

DAIO’s largest end market is automobiles. The strategy to pursue a dominant position in autos was implemented by the current CEO when he joined the company in 2012, recognizing that the number of chips per car and the amount of information programmed in each chip was likely to grow. At the very least, the much publicized “chipagedon” validates his thinking. (I’ve appended at the end of this report commentary from other suppliers in the space (chip makers and distributers) to try to offer some better understanding around “chipagedon” and its impact on the business).

A PSV unit is a “capital sale”. Once in place, these units generate aftermarket sales through software licenses, trays to hold different chips and services, et al. One can observe (left chart) significant growth in the recurring revenues, which infers utilization of units in place. Utilization tends to grow ahead of unit sales. Backlog trends (right chart) supports the view of pent up demand, which would be a significant event since unit sales “moves the needle” on profitability.

Longer term, since 2018, the company has been investing in a security component of their business (“SentriX”), which would enable the machines to “embed” into each chip a unique identifier into its “root” programming. Among other things, this “embedded security” would enable manufacturers who use those chips to reduce counterfeiting and provide a better security foundation for IOT products.

The SentriX investment adds $500k-$1M / quarter in incremental R&D expenses and to date there has been no return on this investment. Back out this spend and the company would be profitable. (Back out all R&D and this is trading at 6x trailing EBITDA).

Initially, DAIO had a partner on SentriX but that ended in FY2020. Management is iterating its go to market strategy and has pivoted from selling SentriX specific machines to converting existing machines to the SentriX model, expecting to charge on a per chip basis. They’ve already done this for one client. One can imagine how this could increase the recurring revenue component of existing units in place..."

Our calculations show that Data I/O Corporation (NASDAQ: DAIO) does not belong in our list of the 30 Most Popular Stocks Among Hedge Funds. As of the end of the first quarter of 2021, Data I/O Corporation was in 3 hedge fund portfolios, compared to 4 funds in the fourth quarter of 2020. DAIO delivered an 18.63% return in the past 3 months.

The top 10 stocks among hedge funds returned 231.2% between 2015 and 2020, and outperformed the S&P 500 Index ETFs by more than 126 percentage points. We know it sounds unbelievable. You have been dismissing our articles about top hedge fund stocks mostly because you were fed biased information by other media outlets about hedge funds’ poor performance. You could have doubled the size of your nest egg by investing in the top hedge fund stocks instead of dumb S&P 500 ETFs. Here you can watch our video about the top 5 hedge fund stocks right now. All of these stocks had positive returns in 2020.

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Disclosure: None. This article is originally published at Insider Monkey.