Analog Devices’ stock (NASDAQ: ADI) is down around 3% since the beginning of this year, but at the current price of $114 per share, we believe that Analog Devices stock could see further downside.
Why is that? Our belief stems from the fact that Analog Devices stock has risen 35% from the low seen in early 2018. Our dashboard What Factors Drove 35% Change In Analog Devices Stock Between 2017 And Now? provides the key numbers behind our thinking, and we explain more below.
Analog Devices is a semiconductor company, manufacturing products used in a variety of applications such as signal processing and power management. The stock rise over the past two years came due to a 14% growth in revenue, which translated into a strong 69% growth in net income. Net Income rose due to rising gross margins (67% in 2019 vs 60% in 2017) and a drop in the effective tax rate (8% in 2019 vs 13.8% in 2017). This, combined with a 6% rise in outstanding share count, led to a 58% growth in earnings on a per share basis.
However, Analog Devices’ P/E ratio dropped from 36.5x at the end of 2017 to around 32x at the end of 2019. While its P/E has dropped further to roughly 31x currently, given the volatility of the current situation, there is significant possible downside for Analog Devices’ multiple, especially when compared with previous years: 24.5x at the end of 2016, and 20.5x as recently as 2018.
So what’s the likely trigger and timing to this downside?
The global spread of Coronavirus has meant there is much lower demand for computing and hardware devices across all markets, which means lower semiconductor demand, and lower demand for Analog Devices’ products. Analog Devices’ Q3 2020 results confirmed this, with revenue dropping to $1.45 billion vs $1.48 billion for the same period last year. Cost of sales stayed at the same level, but a drop in non-operating expenses led to EPS coming in unchanged at $0.98. We expect this trend in revenue to continue in the medium term, and this could also weigh down earnings. We believe Analog Devices’ Q4 results in October will confirm this, and will also likely accompany a lower 1H 2021 guidance.
Regardless, if there isn’t clear evidence of containment of the virus anytime soon, we believe the stock will see its P/E multiple decline from the current level of 31x to around 28x, which combined with a slight reduction in revenues and margins could result in the stock price shrinking to as low as $100.
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