As we explained yesterday, small-cap investments are a historically-proven way to beat the market. 

Our goal when we started Project Alpha was to selectively pick small-cap stocks which could outperform the market without excess risk. Since our first pick in March of last year, the Project Alpha portfolio has returned 12.8% while the S&P 500 has returned a meager 0.19%.

#-ad_banner-#While Project Alpha was originally reserved for premium subscribers, we have decided to open the series to all our readers. And today, we are excited to bring you our first new pick this summer.

This Misunderstood Company Could Be The Next Big Tech Breakthrough

Though small caps outperform the market in the long term, these picks are far from a dime a dozen. In fact, small-cap companies often face more obstacles than their larger counterparts.

One of the biggest difficulties small-cap companies encounter is staying on top of innovation. Frequently strapped for R&D capital, these firms can easily be crushed by well established companies with huge budgets and armies of researchers.

It’s even harder for these companies to achieve sufficient market penetration, and it is rare for them to gain the traction needed to compete with the “big kids” on the block.

Yet today, we’ve found the needle in the haystack: a small-cap company with cutting-edge technology poised to break into mass-market adoption.

Tessera (Nasdaq: TSRA) operates at the forefront of technological innovation, developing and licensing cutting edge semiconductor packaging and imaging solutions to its clients. The firm’s 4036 patents encompass key components of mobile computing, image stabilization, 3-D integrated circuits, photo imaging, sensors, and data storage.

Tessera is involved with just about every tech buzzword you can think of. Drones? They use Tessera’s state-of-the-art image stabilization technology. Biometric detection? The newest iPhone and Samsung Galaxy S7 fingerprint sensors both use the firm’s Direct Bond Interconnect (DBI) platform. Internet of Things? This company’s got the lowest cost, ultra-high performance semiconductor packaging on the market. Smart cars? 360 sensors and driver monitoring could be direct applications of the firm’s imaging solutions.

Tessera’s 3D-IC technology has been dubbed the “next major inflection in semiconductor packaging,” set to revolutionize networking, data storage, and computing. In an age where we spend unprecedented amounts of time glued to our mobile devices, Tessera’s camera and image sensor technologies feature low power consumption while delivering high quality performance.

Not only is Tessera’s portfolio full of exciting technologies, but these innovations are also on the brink of mass market adoption, thanks to the firm’s contracts and partnerships with some of the biggest names in tech.

Tessera recently hit an important milestone when Sony, the world’s largest image sensor manufacturer, utilized Tessera’s DBI platform in Samsung’s flagship smart phone, the Galaxy S7. This release set a new bar for image quality in smart phones and validates DBI’s readiness for high-volume manufacturing. The company’s imaging software is already found in 1.2 billion smart phones and as other phone manufacturers strive to meet this new standard of visual performance, Tessera can expect an increase in demand for DBI licensing.

Intel, the dominant player in semiconductor manufacturing, also licenses Tessera’s Bond Via Array (BVA) packaging technology. Contracts with Intel and Samsung expose Tessera to a combined market share of 26.2% in this $54.2 billion industry, no easy feat for a small-cap company.

On April 18th, Tessera announced a license agreement with premier government research institution, Sandia National Laboratories. Sandia is currently exploring possible deployments of the company’s innovations in a wide variety of semiconductor applications.

With prospects as bright as this, you would expect for TSRA to be trading at astronomical multiples.

However, as you can see from the table below, Tessera is trading far below the industry average with a P/E of 15.3, P/FCF 11.6, and PEG Ratio 0.7.

So what is the market not seeing?

On a surface level Tessera is easily misunderstood. A cursory glance at the income statement seems to indicate that revenues have been declining since 2014. A simple Google search brings up a list of recent lawsuits the company has been involved in.

But a deeper examination reveals that the decrease in revenue is far from evidence of declining performance. The $5.5 million drop in top line was due to the loss of $98 million in episodic revenue, or one time payments in 2014. However, this was almost entirely compensated for by the $92.5 million increase in recurring revenue, which will continue for years until the licenses expire. In fact, recurring revenue is up 60% from 2014. 

Additionally, cash flow from operations is at an all time high, and management just approved of a $200 million share repurchase program. This usually indicates that the firm believes its shares are undervalued and it is a way for the company to return money to its shareholders. With profit margin at 30.2% and continuing to grow, the firm’s financial health is far from a concern.

The patent and licensing industry has long been riddled with frequent litigation. To protect its intellectual property, Tessera has recently been involved in lawsuits with Toshiba, UTAC and Amkor. However, UTAC and Amkor have recently settled with agreements strongly in TSRA’s favor. UTAC will be paying $18 million over the next three years and Amkor will be paying $155 million in 16 quarterly payments into 2018. These settlements set a strong precedent for litigation challenges and with over $381 million in cash, Tessera is adequately equipped for future lawsuits.

Risks To Consider: Since Tessera’s revenue comes exclusively from royalty fees, the firm’s revenue figures lag by one quarter because they cannot be reported until their clients release their earnings. This increases the difficulty of creating accurate revenue projections.

Action To Take: Tessera is strategically positioned to capitalize on a number of innovative fronts, holding contracts with many leaders of the tech industry. Undervalued when compared to its peers and in solid financial health, TSRA is a good investment at the most recent price of $32.05.

Editor’s note: Tessera isn’t the only company capitalizing on new technology trends. In his newsletter Game-Changing Stocks, Andy Obermueller has found a company that holds 7,300 patents in virtual reality — a $150 billion industry that’s expected to take off. If you get in now, you could see 228% gains in the next 12 months. Click here for more details.