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No Semiconductor Company Has Been Able to Beat Linear Technology's Profitability

July 22, 2014 | About:
ovenerio

ovenerio

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According to the Semiconductor Industry Association (SIA), worldwide sales of semiconductors reached $26.34 billion for the month of April 2014, an increase of 11.5% from the April 2013 with sales of $23.62 billion. The good news is that it is expected that this trend continue during the 2014 and 2015.

In this article, let's take a look at one firm in this highly cyclical semiconductor industry, which is capital-intensive and requires investments to advance in technology and reduce manufacturing costs.

High Quality Standards

Linear Technology Corporation (LLTC) which designs, makes and markets a broad line of high performance standard linear integrated circuits (ICs) that address a wide range of real-world signal processing applications.

Linear specializes in High-Performance Analog (HPA), which require extreme precision and reliability. The purchasing decisions are based on performance rather than price, due to the low proportion of these products in the total cost. The company´s chips are considered to be products that have long life and superior technology, so this is a clear advantage over new entrants. Further, the firm has a successful ability to retain its top talent people. The combination of these factors made Linear's returns to outpace its peers' over the past years.

To maintain profitability, the strategy followed by Linear is to compete for design wins. In cases where an electronics manufacturer is willing to accept a lower level of quality, the company often concedes these businesses to competitors.

Attractive Dividend Policy

Linear has an attractive dividend policy showing its commitment to return cash to investors in the form of dividends as it generates healthy cash flow on a regular basis. The current dividend yield is 2.2%, which is quite good to protect the purchasing power, especially considering the consistency of track-record dividends payments since 1992.

Revenues, Margins and Profitability

Looking at profitability, the revenue growth has slightly outpaced the industry average. The gross profit margin has increased from the same quarter the previous year and the net profit margin of 33.79% has outperformed the industry average. Moreover, the company increased its bottom line by earning $1.72 versus $1.71 in the prior year. This year, the market expects an improvement in earnings ($1.88 versus $1.72).

Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.

Ticker

Company

ROE (%)

LLTC

Linear Technology

41.44

ADI

Analog Devices Inc.

14.21

MXIM

Maxim Integrated Products, Inc.

18.14

TXN

Texas Instruments Inc.

20.01

The company has a current ratio of 41.44% which is higher than the one exhibit by Analog Devices Inc. (ADI) and Maxim Integrated Products, Inc. (MXIM). In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment, so the ROE of Texas Instruments Inc. (TXN) looks very attractive as well. It is very important to understand this metric before investing and it is important to look at the trend in ROE over time.

 

ROE (%)

Ind. Avg

S&P 500

Q3 2014

35.31

15.71

14.43

Q3 2013

42.95

13.63

13.15

Q3 2012

66.6

18.78

14.26

Relative Valuation

In terms of valuation, the stock sells at a trailing P/E of 26.4x, trading at a discount compared to an average of 91.2x for the industry. To use another metric, its price-to-book ratio of 9.1x indicates a premium versus the industry average of 1.94x while the price-to-sales ratio of 8.4x is above the industry average of 1.75x. The first metric indicates that the stock is relatively undervalued and seems to be an attractive investment relative to its peers.

As we can see in the next chart, the stock price has an interesting upward trend in the five-year period. If you had invested $10.000 five years ago, today you could have $23.679, that is an 18.8% compound annual growth rate (CAGR).

1406002064082.png

Final Comment

As outlined in the article, the superior design and solid performance make Linear to generate returns that exceeds the industry average. The strategy followed over the years by focusing on high-performance analog chips as well as retaining people, increased differentiation over peers and makes Linear an attractive choice.

Despite the effects of the economic crises, Linear should benefit from an improved in the global economy, so I would recommend fundamental investors to consider this attractive option for their long-term portfolios.

Hedge fund gurus like Mario Gabelli (Trades, Portfolio), Ray Dalio (Trades, Portfolio), Jeremy Grantham (Trades, Portfolio), Joel Greenblatt (Trades, Portfolio), Jean-Marie Eveillard (Trades, Portfolio) and Jim Simons (Trades, Portfolio) added this stock to their portfolios.

Disclosure: Omar Venerio holds no position in any stocks mentioned

About the author:

ovenerio
We provide independent fundamental research and hedge fund and insider trading focused investigation.

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