You will find it hard to uncover a stock as good as Analog Devices (NASDAQ:ADI). While Nvidia (NASDAQ:NVDA) has been the semiconductor stock attracting the headlines this year, ADI simply plods along, growing revenues, profits and, generally, share price.
Few semiconductor companies come close to achieving what Analog Devices has over the past decade or more, not least because the industry is famous for its commoditization trends that demand engineers build faster, more powerful circuits at lower costs, every few years. The economics are so difficult it’s a virtual miracle any semi firm survives, let alone thrives like Analog Devices.
So what is the special sauce that enables ADI to power higher year after year, decade after decade?
Analog Devices Is Mis-Understood
In a digital world, many a non-engineer will simply pass on considering Analog Devices based on its name alone. Why buy a semiconductor company that deals with analog circuits when the world is going digital?
The fallacy of that line of thinking is the world is analog and so digital circuits must connect to analog ones that interface with the world. And that connection between the digital world and the real world is where ADI has found a special place in the semi industry.
By carving out a niche in the semiconductor world, Analog Devices has managed to steadily grow over time from $678 million in quarterly revenues back in 2013 to $3.07 billion last quarter. Operating income grew, too, from $209.6 million to $953 million.
This is an $83 billion market capitalization firm generating close to a billion a quarter in EBIT, an impressive feat by any measure, and it has translated to a steadily rising earnings per share too. EPS has risen from $0.63 per share to $1.74 per share in the intervening period.
In spite of the stunning fundamentals over the past decade, the share price this year has been somewhat underwhelming, up just 4.1% relative to the stock market’s 14.55% spike. But perhaps that relative underperformance has translated to a bargain for prospective investors.
Is Analog Devices Stock Undervalued?
While the ordinary investor may have glossed past Analog Devices, Al Gore’s fund, Generation Investment Management has loyally held it for about a decade (via its acquisition of LLTC). They continue to hold the position and it’s no surprise why.
Analog Devices is undervalued by 23.2% to fair value of $208 per share according to a discounted cash flow forecast analysis. The consensus among 23 analysts is that Analog Devices is undervalued by 19.0% with a price target of $199 per share.
The price-to-earnings ratio of ADI would not suggest it’s a steal at this time, given that it sits at 22.4x, above the sector average of 10.4x. It is worth noting though that it’s a very reasonable number when compared to stock market darling Nvidia that has a 110x P/E ratio.
Is Analog Devices a Good Stock To Invest In?
Few stocks can claim to stand head and shoulders above Analog Devices. It’s a great stock to invest in for a number of reasons, including a streak of raising its dividend payout for 20 years, paying a 2.0% dividend yield, steadily increasing its earnings per share and revenues over the last decade, and for the most part, trading with relatively low share price volatility.
The company’s balance sheet is a thing of beauty too. Cash levels have climbed from $392 million a decade ago to $1.1 billion last quarter. Admittedly, long-term debt is up from $5.1 billion to $6.4 billion.
Make no mistake about it, though, Analog Devices is a money machine, spitting out an astonishing $935 million of operating income on $3.07 billion in revenues. To put that in perspective, the ratio of EBIT / Revenues is 30.4%, eclipsing even the most iconic of firm’s, Apple, which has an equivalent ratio of 30.2%.
The profitability metrics of the firm stand out too, with return on invested capital sitting at a very respectable 9.3.%, net income to common margin at 29.2%, and return on equity of 10.3%.
Where Will Analog Devices Stock Be In 5 Years?
A 5-year EBITDA exit discounted cash flow forecast analysis projects that Analog Devices share price will be worth $240 per share.
It’s not entirely clear whether that forecast will hit a few bumps in the road over the next few years as the effects of higher rates take their toll on the economy, and in particular customers of ADI.
Still, it’s hard to bet against a company that has consistently delivered gross margins of close to 65% and squeezed out operating income margins north of 30%. Those metrics have remained in place through thick and thin, from flash crashes to health scares, and through bear markets and bull ones.
With the share price underperforming this year, arguably there is no better time to consider a position than now.
Is Analog Devices Stock a Buy?
Over the past six months, Analog Devices stocks has tumbled by 8% and is up just 4% for the full year-to-date. That represents a considerable underperformance relative to the S&P 500. Yet ADI has many strengths, not least gross and operating margins that most any company would envy.
A valuation argument can be made now but the firm’s P/E ratio is sufficiently elevated that it’s not a slam dunk bargain.
Nonetheless, as Warren Buffett has famously said, it’s often better to get a great company at a fair price than a poor company at a great price. Analog Devices has firmly cemented its position in the semiconductor industry as a great company, and appears now to be trading at a fair price.
This isn’t a company that will wow traders with huge price swings or soaring returns as Nvidia has done over the past year, up 222% at last count. It’s more like a mule that ambles uphill slowly, but it continues to do so predictably and reliably, until you look back and see just how far it has come.
Analog Devices has come a long way, up 93% in the past 5 years and an astonishing 2,533% since inception. There is little reason why the next decade won’t bring further impressive returns.
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.