The Opportunity in "Stealth Small Cap Stocks" is Staggering

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Most folks believe that the only way to pull down the really big profits in tech is to find an undiscovered small-cap stock and ride the high-risk pick for all its worth.

But I'm going to let you in on a secret of mine: Big-cap stocks – if you catch them at just the right point – can deliver even bigger returns than their small-cap counterparts … and often with less risk.

I sometimes jokingly refer to these lucrative tech plays as "stealth small caps."

They are one of my favorite profit opportunities to uncover. And when you can tie one of these stocks to a big trend or some other similarly powerful catalyst, the profit opportunity can be staggering.

In fact, I'm going to tell you about one such profit play today …

Last week, I told you that cloud computing will generate the kind of windfall profit opportunities that investors can usually only dream about. This push to store everything from your company's software and corporate records to your family photos out on the Web instead of on your desktop hard drive is creating a business opportunity that researchers say will explode by nearly 500% in a decade.

The fact is that cloud computing is one of those technology advances that is reshaping the business landscape. That means there will be a plethora of fast-growing, small-cap profit plays in areas like hosted data centers, computer memory systems, network security and data storage.

But a paradigm-shifting invention like cloud computing that's powerful enough to give birth to lots of new little companies like that also has the power to give new life to some longstanding high-tech stalwarts – energizing their profit growth and causing their stock prices to rocket.

It's like they've been given a dose of "digital Viagra."

A "Target Rich" Environment

That's good for us because it broadens our list of potential investments into a target-rich environment.

I usually think of the stocks of big tech firms as being "slow and steady." There's not as much risk as with a small-cap stock, but the downside is that you can't expect the souped-up returns you expect from these small, emerging tech ventures.

But the cloud is quickly changing that dynamic. By moving data and applications either to the Web or to "private clouds" – data centers hosted by vendors – some big cap firms are being presented with completely new growth opportunities. That demonstrates the power of Rule No. 2 – ride the unstoppable trends – of my five-part system for building tech wealth.

By reinvigorating the big-cap tech players – and giving them new markets to grow into – the cloud has created a "target-rich" environment of profit plays for us to choose from.

But there's one in particular that you need to take a look at.

I'm talking about Adobe Systems Inc. (NasdaqGS: ADBE), the San Jose-based tech veteran that's using the cloud to turn its business inside out.

Founded in 1982, the Silicon Valley firm is already one of the world's most respected software firms. Most investors know Adobe as the maker of software that creates the popular PDF files found on the Internet and also used as email attachments.

Turns out, Adobe also is the world leader in software used by designers, artists and illustrators to create sales brochures, newsletters, catalogues magazines and web sites.

Its Photoshop suite is the industry standard for managing and editing pictures. Adobe Illustrator is the go-to software for creating, editing and managing graphics.

These are very complex packages with millions of lines of code that take two years to develop. And that doesn't take into account all the other steps it has to go through to get the software to market such as burning CDs and packaging and shipping products to retailers.

Each of those steps is a profit killer …

Adobe is tapping this emerging tech venue as a brand-new, low-cost sales channel that will supercharge its growth and give the company small-cap profit potential.

Given that the firm brings in roughly $4.1 billion in sales of licensed and packaged software, just reducing costs by a mere 10% could mean a $400 million improvement in the bottom line.

By capitalizing on the benefits afforded by the cloud, Adobe will soon stop shipping physical products or allowing for digital downloads directly to customer desktops. Instead, clients will subscribe to Creative Cloud and pay a monthly fee to use a suite of software packages.

For its part, Adobe will host the software on its own computer servers and will offer customers discounts of about 40% for the first year of use. After that an annual contract for individuals will run about $50 a month.

Paying the monthly fees gives clients access to several software packages for one simple price as well as steady stream of "free" updates.

So, you can see that Adobe has a lot riding on its new Creative Cloud…

And there's another big reason why the firm could get a big boost in sales. With Creative Cloud, Adobe will virtually eliminate piracy of its products.

The Business Software Alliance, a trade group, estimates that pirated products account for about one in five software packages in use as of 2011, the last year for which statistics were available.

Some of Adobe's software can run $1,200 to $1,500. So, many smaller or medium-sized firms will buy one or two legal packages and then pass purloined copies around the office. You just can't do that when the software lives in the cloud.

If Adobe just fell in with the industry's average, Creative Cloud easily could expand sales by 20% simply by stopping all that theft in its tracks.

Add it all up, and Adobe's move has winner written all over it…

Right now, Adobe has more than 500,000 Creative Cloud subscribers, a figure that is growing by 12,000 a week. But by the end of its fiscal year 2015, Adobe expects that number to increase to four million monthly users.

That's a roughly eightfold increase in cloud users in just about three full years. Adobe launched the cloud platform roughly a year ago on a trial basis but announced the full switch over in early May.

The bottom line: Expect profits to start growing by more than 40% starting a few months.

And that's just the beginning: I expect this move to the cloud to greatly improve Adobe's profits in the long run.

But there's a great entry point looming. As you can imagine, the shift to a new platform will hurt profits in the short term as the company ramps up spending on cloud equipment and infrastructure, allows sales discounts and takes restructuring charges.

Analysts polled by Thompson Reuters expect Adobe to earn about $311 million on about $4.1 billion in sales for the fiscal 2013 year that ends in November. That's less than half of what it earned on roughly the same revenue the year before.

But starting in 2014, profits are set to explode…

Analysts expect earnings to more than double that year to about $697 million. After that, I'm projecting annual profit growth of about 22% a year – a 46% improvement from its 15% average over the past three years.

At that rate, profits could double in a little more than three years.

That's a lot of earnings growth for a firm with a $21 billion market cap and whose stock trades at roughly $42 a share.

At the very least, the new cloud sales model will greatly enhance Adobe's cash position. The company already does a great job here, bringing in more than $1 billion a year in free cash flow.

Thus, Adobe's cloud strategy is set to make the firm into a crown jewel of the software industry. It already sells products that creative professionals working in every industry must have.

Now, its lowered cost structure and higher operating margins will turn it into a true profit powerhouse.

A little "digital Viagra" goes a long way – especially for a "stealth small cap."

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About the Author

Michael A. Robinson is one of the top financial analysts working today. His book "Overdrawn: The Bailout of American Savings" was a prescient look at the anatomy of the nation's S&L crisis, long before the word "bailout" became part of our daily lexicon. He's a Pulitzer Prize-nominated writer and reporter, lauded by the Columbia Journalism Review for his aggressive style. His 30-year track record as a leading tech analyst has garnered him rave reviews, too. Today he is the editor of the monthly tech investing newsletter Nova-X Report as well as Radical Technology Profits, where he covers truly radical technologies – ones that have the power to sweep across the globe and change the very fabric of our lives – and profit opportunities they give rise to. He also explores "what's next" in the tech investing world at Strategic Tech Investor.

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