In this article, let's take a look at Analog Devices, Inc. (ADI, Financial), a $17.28 billion market cap company, which is a company that manufactures high-performance integrated circuits (ICs) used inanalog and digital signal processing applications.
Diversifying Markets
The US semiconductors industry is known for its technological advancements as well as having a great correlation to global GDP. In fiscal 2013, revenues were about $2.6 billion and were obtained from: Industrial, Communications, Consumer and Automotive markets. Except automotive and communications, all the rest of the markets have declined in that year.
Analyzing last year revenues, the key markets are the same; the industrial market which accounted for approximately 47% of sales in FY 14 (Oct.); communications with 24%; consumer with 11%; and automotive with 18%. Taking into consideration this, we believe the firm must continue focusing on the automotive market, because it had experienced a strong growth for the fourth consecutive year.
Liquidity
The company has a quick ratio of 4.91, which is ranked higher than 90% of the semiconductors industry, and a debt-to-equity ratio which is very low and currently below that of the industry average. These ratios mean that there has been a good management of debt levels because they show the ability to cover cash needs, at least in the short term.
Corporate Strategy
Analog Devices plans to continue to invest heavily in R&D in order to create new products, preferably on the industrial and automobiles markets. For example, apart from traditional cars, which added electronic content, hybrid and electric autos are almost tripling the amount of chip content inside of them, so this a good opportunity to increase sales.
Revenues, Margins and Profitability
Looking at profitability, revenues rose by 20.04% but earnings per share decreased in the most recent quarter compared to the same quarter a year ago ($0.34 vs $0.64). During the past fiscal year, the company reported lower earnings of $1.98 versus $2.14 in the previous year. This year, Wall Street expects an improvement in earnings ($2.84 versus $1.98). Regardless of these weak earnings results, the stock is trading higher as we are going to see later.
The company´s gross profit margin is at high levels, at more than 70%, as well as its net profit margin of 22.91%, which is ranked higher than 96% of the 1108 Companies in the Semiconductors industry.
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 | Analog Devices | 12.99 |
| TXN | Texas Instruments | 26.74 |
| MU | Micron Technology | 36.25 |
| BRCM | Broadcom Corp | 7.52 |
| AVGO | Avago Technologies Ltd | 8.55 |
| Â | Industry Median | 4.91 |
The company has a current ROE of 12.99% which is higher than the one exhibit by Broadcom Corp (BRCM, Financial) and 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, Texas Instruments and Micron Technology (MU, 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 28.0x, trading at a discount compared to an average of 60.0x for the industry. To use another metric, its price-to-book ratio of 3.67x indicates a premium versus the industry average of 2.0x while the price-to-sales ratio of 6.16x is above the industry average of 1.93x.
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 $22.298, which represents a 17.4% compound annual growth rate (CAGR).
As we can appreciate, the stock is trading at a higher level than it was a year ago.
Final Comment
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. As outlined in the article, we can see interesting growth opportunities, especially in the auto industry, which would help the sustainability of the growth trends in the next quarters.
The PE relative valuation and the return on equity that significantly exceeds the industry average make me feel bullish on this stock.
So this time I would not follow Brian Rogers (Trades, Portfolio), this hedge fund guru that have reduced position in the last quarter of 2014.
Disclosure: Omar Venerio holds no position in any stocks mentioned
