The past six months have been a windfall for Semtech’s shareholders. The company’s stock price has jumped 46.5%, hitting $77.73 per share. This was partly thanks to its solid quarterly results, and the performance may have investors wondering how to approach the situation.
Is now the time to buy Semtech, or should you be careful about including it in your portfolio? Get the full breakdown from our expert analysts, it’s free.
Why Do We Think Semtech Will Underperform?
We’re glad investors have benefited from the price increase, but we're swiping left on Semtech for now. Here are three reasons we avoid SMTC and a stock we'd rather own.
1. Operating Losses Sound the Alarms
Operating margin is a key measure of profitability. Think of it as net income - the bottom line - excluding the impact of taxes and interest on debt, which are less connected to business fundamentals.
Although Semtech was profitable this quarter from an operational perspective, it’s generally struggled over a longer time period. Its expensive cost structure has contributed to an average operating margin of negative 27.6% over the last two years. Unprofitable semiconductor companies require extra attention because they could get caught swimming naked when the tide goes out. It’s hard to trust that the business can endure a full cycle.
2. Mediocre Free Cash Flow Margin Limits Reinvestment Potential
If you’ve followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can’t use accounting profits to pay the bills.
Semtech has shown poor cash profitability over the last two years, giving the company limited opportunities to return capital to shareholders. Its free cash flow margin averaged 9.3%, lousy for a semiconductor business.
3. Previous Growth Initiatives Have Lost Money
Growth gives us insight into a company’s long-term potential, but how capital-efficient was that growth? Enter ROIC, a metric showing how much operating profit a company generates relative to the money it has raised (debt and equity).
Semtech’s five-year average ROIC was negative 7.8%, meaning management lost money while trying to expand the business. Its returns were among the worst in the semiconductor sector.
Final Judgment
Semtech doesn’t pass our quality test. After the recent rally, the stock trades at 39× forward P/E (or $77.73 per share). At this valuation, there’s a lot of good news priced in - we think there are better opportunities elsewhere. Let us point you toward one of our all-time favorite software stocks.
Stocks We Like More Than Semtech
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