In this article, let's take a look at Altera Corp. (ALTR, Financial), a $10.41 billion market cap company, which is one of the largest makers of high-performance, high-density programmable logic devices (PLDs) and associated computer-aided engineering logic development tools.
Industry overview
We have three types of integrated circuits used in digital devices: processors, memory products and logic devices, which manage the interchange and manipulation of digital signals within a system.
Logic devices can be divided as well into two categories, fixed and programmable. The programmable logic market, or PLD, is led by the company and Xilinx (XLNX, Financial). PLD chips have the characteristic that can be programmed, so electronics manufacturers’ instructions can be more easily reprogrammed and can customize their circuitries for specific applications.
This is different from the Fixed logic devices, such as application specific integrated circuits (ASIC), which have fixed functionality and cannot be reconfigured. Since both (fixed and programmable logic devices) can be used in the same devices, there is a natural competition between them. Choosing one or another depends on money. PLDs are more costly on a per-unit basis because they are larger. On the other hand, ASICs are cheaper in high volumes but have also higher up-front startup costs. So, PLDs are used in lower-volume electronics applications, in industries such as: industrial, automotive, military, and wireless and wireline communications. Altera offers HardCopy ASICs to make the transition from PLDs to ASICs.
In the last time, the up-front costs of developing cutting-edge ASICs have risen and this make that PLD has expanded over time. We believe this trend will benefit the firm in the future.
PLD market
According to Gartner, Altera has 39% of the market share, while Xilinx holds 50%. This is good considering that there is certain loyalty to a company's products because of the familiarity they gain when they start using one product.
In order to increase share in the PLD market, the company aims to provide products with special features and characteristics to differentiate from the rest of the competitors. It focuses on speed, density, low power consumption, functionality and package type. The idea is to gain low-cost and high volume applications.
The logic segment
This segment is characterized by the continuous technological improvements which generate product obsolescence. The firm invests in research and development, with focus on the design of new ICs, or new software, or new processes searching for cost reductions or other improvements.
Revenues, margins and profitability
Looking at profitability, revenue growth by 16.53% led earnings per share increased in the most recent quarter compared to the same quarter a year ago ($0.41 vs $0.31). During the past fiscal year, the company reported lower earnings of $1.36 versus $1.71 in the previous year. This year, Wall Street expects an improvement in earnings ($1.52 versus $1.36).
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 (%) |
| ALTR | Altera | 13.28 |
| MCHP | Microchip Technology Inc | 19.64 |
| ASX | Advanced Semiconductor Engineering Inc. | 15.16 |
| ADI | Analog Devices Inc. | 14.97 |
| AVGO | Avago Technologies Ltd | 10.10 |
| Ă‚ | Industry Median | 3.79 |
The company has a current ROE of 13.28% which is higher than the one exhibit by Avago Technologies (AVGO, 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, Analog Devices (ADI, Financial), Advanced Semiconductor Engineering (ASX, Financial) and Microchip Technology (MCHP, 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 23.1x, trading at a discount compared to an average of 78.5x for the industry. To use another metric, its price-to-book ratio of 3.1x indicates a premium versus the industry average of 1.93x while the price-to-sales ratio of 5.8x is above the industry average of 1.83x.
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 $18,867, which represents a 13.5% compound annual growth rate (CAGR).
Final comment
Some people believe that Altera's products are better than the Xilinx's offers. Also, the firm is a well-run company with a management that takes good actions.
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 Paul Tudor Jones (Trades, Portfolio) and Ray Dalio (Trades, Portfolio) added this stock to their portfolios in the second quarter of 2014, as well as PRIMECAP Management (Trades, Portfolio).
Disclosure: Omar Venerio holds no position in any stocks mentioned
