With the AI boom still driving tech stocks higher, many investors are now looking for opportunities further upstream in the semiconductor value chain.
One area that nicely fits the bill is electronic design automation, a type of software that helps OEMs design and validate semiconductors.
The EDA market is currently dominated by two large businesses, Cadence (NASDAQ:CDNS) and Synopsys (NASDAQ:SNPS).
Let’s examine which one of these two EDA stocks could be the better buy for investors today.
Cadence
Cadence is a fast-growing EDA business that, in its most recent quarterly report, detailed revenues of $1.28 billion against just $1.06 billion in the year-ago quarter.
Though GAAP net income per share fell substantially, this was largely the result of a one-time settlement charge. Going forward, analysts expect to see Cadence deliver annualized EPS growth of nearly 15 percent through much of the rest of this decade.
Unsurprisingly, Cadence shares are currently trading at a fairly hefty premium. CDNS commands multiples of 93.3 times earnings, 18.6 times sales and 59.6 times operating cash flow, none of which make the stock look cheap. Analysts have placed the average 12-month price target of $367.14 implying an upside of just 6.4 percent.
Though Cadence and Synopsys both generate recurring revenue from software subscriptions, Cadence has a tighter focus on EDA software. Synopsys, by comparison, puts greater emphasis on its licensed IP assets so It may be a slightly more diversified business, but Cadence enjoys somewhat greater direct exposure to the growing demand for its EDA tools.
Cadence is also the only business with a similar market share to Synopsys. While Synopsys still notches a narrow win with its 38 percent market share, Cadence is extremely close at 36 percent. Given the rapid growth that AI demand is producing in the semiconductor market, it’s likely that both businesses are well-positioned to benefit from ongoing market expansion over several years.
Synopsys
Synopsys’ Q2 results showed a slower rate of revenue growth than Cadence’s for the same period, with revenue rising from $1.46 billion to $1.60 billion. The revenue did, however, come in above the midpoint of management’s guidance for the quarter. Moreover, GAAP EPS rose from $1.92 in the year-ago quarter to $2.24, representing a year-over-year growth rate of over 16 percent.
While Synopsys is delivering stronger earnings growth than Cadence right now, analysts expect its 3-5 year EPS growth rate to be very comparable to Cadence’s at about 15 percent annually. This similarity is far from surprising, given that both businesses are operating on similar models in the same industry and being driven by essentially identical growth trends.
Though not exactly cheap itself, SNPS trades at a somewhat lower valuation than CDNS. Shares are currently priced at 43.8 times earnings and 15.2 times sales. It’s worth noting, however, that Synopsys trades at a higher multiple of 87.2 times operating cash flow.
Despite being priced at generally lower multiples than Cadence, analysts only expect about 5 percent of upside from its shares in the coming 12 months. Synopsys has also lagged Cadence’s returns over the last year, delivering a trailing 12-month return of 10.7 percent to Cadence’s 26.0 percent.
Interestingly, Synopsys outperforms Cadence by many profitability metrics, despite its lower overall valuation. Synopsys’ net margin and return on invested capital over the last 12 months have totaled 34.8 percent and 20.3 percent, respectively. Cadence, by comparison, has delivered a net margin of 19.9 percent and an ROIC of 14.4 percent.
There is, however, a difference in Cadence’s favor where gross margin is concerned. On a trailing 12-month basis, Synopsys has delivered a gross margin of just under 80 percent. Cadence, even after experiencing a period in which gross margins contracted, delivered just over 85 percent. Although Cadence has an edge in this area, it likely isn’t enough to make a massive difference when comparing the two stocks as long-term holdings.
Cadence Vs Synopsys, Which Stock Is Better?
In many ways, Cadence and Synopsys are both very strong businesses with comparable characteristics. The two businesses even have very similar expected earnings growth rates through the rest of this decade, suggesting that they’ll likely follow very similar trajectories powered by the ongoing demands of AI and other advanced semiconductor manufacturing. Even in terms of market share, Cadence and Synopsys account for very similar pieces of the overall EDA market.
Both Cadence and Synopsys are actively using AI in their own software tools in addition to benefiting from the AI boom indirectly. Both businesses have rolled out AI-powered tools meant to accelerate design. Being that both are investing heavily in this area, it doesn’t seem that one will gain a strong edge over the other when it comes to AI-enhanced design tools. Both, however, will likely benefit from continued investment in such tools on the part of their customers.
With so many things being more or less equal, there’s a good argument to be made that Synopsys is likely a slightly better investment than Cadence. If earnings growth between the two proves to be comparable, as analysts currently expect, Synopsys’ lower value multiples would seem to tilt the scales in its favor.
This case for SNPS is added to by the fact that the business is already delivering somewhat higher profitability than Cadence, meaning that investors who buy Synopsys are likely getting both better margins and comparable growth at a lower price tag.
Even with this distinction made, it’s worth noting again that both Cadence and Synopsys are likely to do quite well over the next several years.
As the two majors in EDA, these two businesses are primed to benefit from entrenched secular trends. Even more important to recognize is the fact that many customers buy software from both Cadence and Synopsys, using them for different purposes to enhance workflows. As a result, there doesn’t seem to be much chance of a major breakout in which one business suddenly takes a meaningfully larger market share than the other.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.