Is This The Top Software AI Stock?

Cadence Design Systems, Inc. (NASDAQ:CDNS) is one of the leading providers of software and design solutions to the electronics industry, with more than 30 years of expertise in this space.

Shares of this electronic design automation (EDA) software company saw a solid run in 2023 as it advanced into the booming artificial intelligence (AI) space. The stock reached its 52-week high of $320.78 per share on March 4, demonstrating solid momentum.

Cadence is also a long-term winner, delivering market-beating returns over the past five years and gaining more than 400%. Over the same time frame, the S&P 500 has rallied by more than 80%.

Optimism surrounds the stock thanks to aggressive growth for semiconductors more generally as they support AI workloads. Cadence is at the intersection and benefitting from mega-trends like AI, data science and 5G.

The AI chips market was valued at $53.5 billion last year and is expected to grow by approximately 30% this year to more than $67 billion, driven by the increasing demand for advanced chips used for powering trends like digitization and automated applications.

However, not everything has been rosy for the firm. The company’s guidance for the fiscal first quarter came in lower than analysts’ expectations, temporarily hurting investor sentiment. This, along with concerns over the Fed’s interest rate decision in its March meeting based on anticipated high inflation, led to the stock losing marginally since its fourth-quarter earnings release on February 12, 2024. 

Market Opportunity Set to 3x

Cadence Design’s revenue of $1.07 billion for the fiscal fourth quarter increased 18.8% year over year and surpassed the consensus estimate by 0.7%.

Moreover, its non-GAAP EPS grew 43.8% from the year-ago quarter to $1.38, topping the Wall Street estimates by 3.7%. Its non-GAAP operating margin was 43%, higher than the prior-year quarter margin of 36%.

Higher demand for design solutions and strong operational performance boosted its top line. Cadence ended the year with a record backlog of $6 billion and current remaining performance obligations (cRPO) of $3.2 billion amid an increasing customer base for its chip-to-system integrated design and analysis platforms.

Management highlighted strong momentum in broad-based design activity amid secular trends of digital transformation, hyper-scale computing and autonomous driving. They are focusing on an Intelligent System Design strategy, which is forecast to triple the firm’s TAM opportunity while also expanding its portfolio.

Partnerships Powering Billion Dollar Opportunities

Recently, Cadence announced its agreement to acquire BETA CAE Systems International AG, a leading system analysis platform provider of multi-domain engineering simulation solutions.

The company expects this acquisition to accelerate its Intelligent System Design strategy by expanding its multiphysics system analysis portfolio and enabling entry into the structural analysis segment. Moreover, the collaboration is expected to unlock a multi-billion-dollar incremental TAM opportunity.

In addition, the company is expanding its partnerships with prominent leaders to strengthen its position in the industry. For example, Cadence extended its collaboration with Intel Foundry through a multi-year agreement to provide design software and leading IP at multiple levels.

Furthermore, Cadence’s long-standing collaboration with chip giant NVIDIA Corporation (NASDAQ:NVDA) is worth noting. The companies have collaborated through a meaningful expansion of hardware solutions and EDA software.

With all that said, management expects first-quarter revenue to be between $990 million and $1.01 billion, while analysts had forecast a little more. Also, its non-GAAP EPS for the current quarter is expected to be between $1.10 and $1.14, lower than consensus expectations.  

While the first quarter guidance slightly disappointed investors, it is worth considering the company’s long-term growth prospects and management’s guidance for fiscal 2024 shows promise.

Cadence is investing heftily in bolstering its AI capabilities and looks well-positioned to ride the trends of next-generation technologies.

Is Cadence’s Movement in the AI Space Noteworthy?

CDNS has been ramping up efforts to capitalize on the AI revolution. The company is strengthening its generative Cadence.AI portfolio, which includes a wide range of artificial intelligence offerings spanning from chip to board to system.

Last year, the company introduced Virtuoso Studio and Allegro X AI to integrate AI into custom/analog and PCB designs. Also bolstering the Cadence.AI generative AI portfolio are Voltus InsightAI for automatically addressing voltage drop violations and Celsius Studio for AI-driven full-system thermal analysis.

In addition, Cadence introduced the revolutionary Millennium M1 platform, the industry’s first accelerated multiphysics supercomputing platform that combines AI, HPC and digital twin technology, delivering 20x energy efficiency and up to 100x design impact.

The Cadence.AI portfolio increased the number of customers adopting its GenAI solutions by almost tenfold in 2023. Its growing customer base is evident as its digital software is rolling in all top 20 semiconductor companies, while 34 additional customers adopted its digital full flow during the year. Moreover, the firm’s hardware segment added 26 new and over 110 repeat customers during the year.

How High Will Cadence Design Systems Go?

According to 17 analysts, Cadence Design Systems can rise to as high as $316 per share, representing 2.8% upside from current levels.

While the upside is modest, 9 out of 12 analysts recommended buying the stock, and three rated a “Hold” on the stock.    

The high forecast is $350 per share while the lowest pegs fair value at $240 per share.

Is It Worth Paying the Premium for Cadence Stock?

Given its supercharged run over the past few years, the stock currently trades at a premium valuation. Its non-GAAP trailing-12-month price-to-earnings (P/E) ratio of 59.92 is significantly higher than its industry peers.

However, the booming portfolio of AI solutions is capturing a significant share in this burgeoning market, and boosting the company’s prospects.

Considering the solid growth potential, which could drive the stock to new highs, paying the premium may very well make sense.

While macroeconomic concerns remain, the stock’s momentum is not expected to wane anytime soon, thanks to the hype around AI. As such, investors looking to cash in on the hyper-trend of AI may want to keep this on their watchlist, and be prepared to pounce, especially on a pullback.

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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.