Universal Display Corporation (OLED, Financial) has a fortress balance sheet and a high level of profitability. It's also overvalued, but thanks to its volatile prices, entry with a margin of safety may become possible. Here is its five-year saw-toothed price chart:
The company researches, develops and commercializes organic light-emitting diode (OLED, Financial) technologies and materials. These OLEDs are used in display and solid-state lighting applications.
It has numerous competitors, including some of its partners. One of them is the Samsung Display Company, with which Universal licensed some of its technologies in 2018.
OLEDs are used in cell phones because they consume less power than LEDs. In addition, they are thin, efficient, flexible and transparent. Other applications are shown in this slide from its August 2020 investor presentation:
Here is howthe company compares its OLEDs with LCD technologies:
Universal expects the market for its products to grow by 37% over the next four years. The company is well-positioned to compete for a larger piece of that market, as the GuruFocus system gives it a rare 10 out of 10 score for financial strength and an 8 out of 10 score for profitability. In other words, its fundamentals are very robust.
Behind this success is research and development that leads to patents, the gold mines of the technology industry. Universal has more than 5,000 of them:
"We develop and license enabling technologies that are at the heart of consumer OLED products worldwide, from AR/VR, smartwatches, smartphones, IT, automotive and TVs to lighting products."
Research is focused in three areas:
- Lower power usage
- Superior aesthetics
- Cost-effectiveness
At the end of calendar 2019, 217 of Universal's 309 active full-time employees were research scientists, engineers and laboratory technicians. Creating and maintaining a research and development operation is costly, and as this 10-year chart shows, the free cash flow trend is headed upward:
Very little of its free cash flow goes toward dividends and share buybacks. The dividend yield is 0.29% or $0.15 cents per share on a stock worth almost $200. The firm repurchased only 4,011 and 3,774 shares in 2019 and 2018, respectively.
Behind the free cash flow is a set of remarkable metrics, as shown in the table below:
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The margins and the return on equity (ROE) of more than 12% t suggest Universal has at least a narrow moat or competitive advantage. To that, we can add the qualitative assessment that its patents and technological advancements also help establish a moat.
Overall, there seems little to complain about in terms of financial strength, but let's take a closer look.
The company has no debt, meaning it can withstand a lot of external forces. No interest expense means more income reaches the bottom line, which is good for shareholders.
All of the metrics in this table are good, and even the relationship between the weighted average cost of capital (WACC) and the return on invested capital (ROIC) indicate a value-creating company.
Turning our attention to the three last lines on the profitability table, we can see Universal is growing both its revenue and its earnings. It seems unlikely that such growth can continue indefinitely, but at least for the next few years I think the bottom line should grow rapidly, since the company expects the market to grow 37% by 2024.
To put it another way, the market itself will provide roughly 9.25% per year. Universal should get that amount plus additional growth from its own initiatives, including new and better products and expanding into new markets.
In turn, that top-line should drive up the share price, providing capital gains for investors who buy and hold for at least three to five years.
Valuation
Companies that offer promising capital gains are normally not cheap, or even fairly-valued. Instead, we expect to pay a premium; to some extent, that will reflect the company's current earnings and circumstances, and to some extent it will reflect the day-to-day vagaries of Mr. Market.
However, investors who are patient might get Universal stock at a discount. Mr. Market has had something of a love-hate relationship with Universal over the past five years:
If this saw-toothed pattern continues, investors who wait and watch may be able to get Universal shares at less than the current "modest overvaluation." Not all dips will be deep enough to provide an adequate margin of safety, but some likely will.
Dividend and share buybacks
As we've noted, the dividend amounts to $0.60 per year on a stock trading for almost $200. The dividend yield is therefore quite low at 0.28%. The cash dividend is up $0.05 cents, or 50%, from last year.
Still, all the dividend metrics are low—with one caveat. Universal reports in its 10-K for 2019 that it only began paying dividends in 2017 and has continued to pay them every quarter since then. So, the company hasn't had much time yet to build a serious dividend.
It pointed out in the 10-K it intends to keep paying dividends, subject to the approval of the board of directors. Presumably, the company will want to keep paying them without reductions. As management noted in the 10-K, "Moreover, in the event our payment of quarterly cash dividends are reduced or discontinued, our failure or inability to resume paying cash dividends at historical levels could cause the market price of our common stock to decline."
It would also affect the prosperity of many company insiders; insiders collectively own 1.32 million of the 47.1 million shares outstanding.
Universal also has a negative share buyback ratio, which tells us the company has recently been issuing more new shares than it has been buying back, but overall, the share count has remained steady over most of the past decade:
Gurus
Over the past couple of years, investing gurus have mostly trimmed their Universal holdings:
The following gurus have positions in the stock as of their most recent SEC filings:
- PRIMECAP Management (Trades, Portfolio) cut its holding by 6.08% to finish the second quarter with 2,649,415 shares. The firm has a 5.63% stake in the company
- Jim Simons (Trades, Portfolio) of Renaissance Technologies added 16.6% to his holding in the recent quarter to wind up with 772,639 shares on June 30.
- Pioneer Investments (Trades, Portfolio) more than doubled its position, finishing the recent quarter with 19,376 shares.
- Caxton Associates (Trades, Portfolio) established a new holding in the quarter by purchasing 1,433 shares.
Conclusion
Universal Display is an ambitious company with a moat and a rapidly growing market. It enjoys excellent financial strength and profitability. Such a robust position suggests the company should enjoy some serious capital gains in the coming years.
Investors who buy now will have to pay a premium because the stock is overvalued. As I've noted, though, this stock has a saw-toothed price pattern, so it is quite likely there will be price dips ahead. Those who buy a dip have a better chance of earning a profit.
Disclosure: I do not own shares in any of the companies named in this article.
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