In this article, let's take a look at Analog Devices, Inc. (ADI, Financial), a $15.79 billion market cap company, which is a company that manufactures high-performance integrated circuits (ICs) used in analog and digital signal processing applications.
The company is a great analog chipmaker player, which has a strong position in analog converter and amplifier chips, two key products often needed in wireless network equipment.
Long-term profitability
In a more digitized world, more analog chips are required to help digital chips, principally with the transmission or the storage of information.
The analog chips convert sound or temperature into digital signals. Because they are not expensive products to produce, if the firm maintains prices in coherent values, it will generate strong profitability in the future.
New products
The firm focuses on improving profitability, by introducing new offerings in markets which are promising, such as the industrial and automobiles. Further, the company plans to invest heavily in R&D to create those new products with the objective of increasing sales and gross margins. Also, Analog Devices closed manufacturing sites and moved operations to plants that are more cost efficient.
Apart from traditional cars, which added electronic content, hybrid and electric autos are almost tripling the amount of chip content inside of them.
Analog markets
Those markets are attractive because these are not commodity products. The company faces strong competition because there are thousands of designs and many suppliers, but Texas Instruments (TXN, Financial) is still a more diversified rival.
Advantages of analog products include: longer life than digital ones, less competition and lower capital requirements.
Revenues, margins and profitability
Looking at profitability, revenue growth by 7.94% led earnings per share increased in the most recent quarter compared to the same quarter a year ago ($0.57 vs $0.56). During the past fiscal year, the company increased its bottom line. It earned $2.14 versus $2.13 in the prior year. This year, Wall Street expects an improvement in earnings ($2.38 versus $2.14).
The company´s gross profit margin is at high levels, as well as its net profit margin of 24.81%, which is above the industry average.
Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.
| Ticker | Company | ROE (%) |
| ADI | AnalogDevices | 14.21 |
| TXN | Texas Instruments | 20.01 |
| MU | Micron Technology | 13.02 |
| BRCM | Broadcom Corp | 5.07 |
| AVGO | Avago Technologies Ltd | 19.13 |
| Â | Industry Median | 2.69 |
The company has a current ROE of 14.21% which is higher than the ones exhibited by Micron Technology (MU, Financial) and Broadcom Corp (BRCM, Financial). In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. So for investors looking those levels or more, Texas Instruments and Avago Technologies Ltd (AVGO, Financial) could be the options. It is very important to understand this metric before investing, and it is important to look at the trend in ROE over time.
Relative Valuation
In terms of valuation, the stock sells at a trailing P/E of 22.3x, trading at a discount compared to an average of 84.4x for the industry. To use another metric, its price-to-book ratio of 3.2x indicates a premium versus the industry average of 3.19x while the price-to-sales ratio of 5.9x is above the industry average of 1.75x.
As we can see in the next chart, the stock price has an upward trend in the five-year period. If you had invested $10,000 five years ago, today you could have $21,307, which represents a 16.4% compound annual growth rate (CAGR).
Final comment
As outlined in the article, the company is well positioned to profit from growing demand in the future. Further, it plans to continue investing in R&D for new products to offer, especially to the auto industry.
The PE relative valuation and the return on equity that significantly exceeds the industry average and make me feel bullish on this stock.
Hedge fund gurus like Ray Dalio (Trades, Portfolio), Jean-Marie Eveillard (Trades, Portfolio), Jeremy Grantham (Trades, Portfolio) and Murray Stahl (Trades, Portfolio) added this stock to their portfolios in the second quarter of 2014.
Disclosure: Omar Venerio holds no position in any stocks mentioned
