GuruFocus has introduced a new ranking that captures all, or most, key fundamental metrics in one number and one graph. Each stock has its own score, listed near the top of the Summary page, between one and 100. The higher the score, the better the stock is likely to perform.
Cadence Design Systems Inc. (CDNS, Financial) is one of the highest-ranking companies. It earns a score of 97, and its graph looks like this:
To briefly summarize what’s going on in the chart, we’ll start by observing that it comprises five areas: profitability, growth, financial strength, momentum and GF Value.
Looking at the individual components on the graph, we see that the closer each component is to the outside of the circle, the better. In Cadence’s case, it receives 10 out of 10 scores for profitability, growth and momentum, as well as 8 out of 10 for financial strength and 5 out of 10 for GF Value. Each of these components corresponds with more detailed sections on the Summary page.
According to GuruFocus, “The GF Score is a ranking system that has been found to be closely correlated to the long-term performances of stocks by backtesting from 2006 to 2021. The stocks with a higher GF Score generally generate higher returns than those with lower GF Scores.”
About Cadence
The company describes itself this way: “Cadence is a pivotal leader in electronic systems design, building upon more than 30 years of computational software expertise. The company applies its underlying Intelligent System Design strategy to deliver software, hardware, and IP that turn design concepts into reality.”
And, more specifically:
“We enable our customers to develop electronic products. Our products and services are designed to give our customers a competitive edge in their development of integrated circuits (“ICs”), systems-on-chip (“SoCs”), and increasingly sophisticated electronic devices and systems. Our products and services do this by optimizing performance, minimizing power consumption, shortening the time to bring our customers’ products to market, improving engineering productivity and reducing their design, development and manufacturing costs.”
This slide, from a presentation accompanying its fourth-quarter and full-year 2021 results, provides highlights about the company:
The company reported in its 10-K for 2021 that its most frequent competitors on the products and tools side are Synopsys Inc. (SNPS, Financial), Siemens EDA and ANSYS Inc. (ANSS, Financial).
The engineering services business competes with other computational software companies, but its main competitors are independent engineering service businesses. Many of them are also customers and use its products in the delivery of their services or products.
Performance
As this 10-year chart shows, Cadence has outperformed Synopsys and ANSYS:
Where does that outperformance come from? Let’s review the five criteria behind the GF Score.
Profitability
A perfect 10 out of 10 score is a rarity among companies, but Cadence has done it. A quick scan of the table tells us why: All the green bars in the History column show it outperforms its peers and competitors on each measure (the darker bars indicate it is the highest or near-highest performer for the metrics; lighter green indicates better than average).
Note that while it grew its revenue by 12.1% over the past three years, its Ebitda growth was even better and its earnings per share outgrew revenue by a better than two-to-one margin. That shows management has made the company more effective and efficient. That’s backed up by the 7 out of 9 Piotroski F-Score in the financial strength table.
Growth
There are four criteria for the growth category (for the first three, higher is better):
- Five-year revenue growth rate
- Three-year revenue growth rate
- Five-year Ebitda growth rate
- Five-year revenue predictability (the more consistent, the higher the rank)
Cadence has a three-year revenue growth rate of 12.10%, which is better than 67% of its 2,130 competitors and peers in the software industry. Its five-year growth rate is 11.40%.
The five-year Ebitda growth rate has averaged 20.40% per year.
The GuruFocus system gives the company a four out of five-star predictability rating overall, and this 10-year chart shows how consistently its revenue and revenue per share have grown:
Financial strength
The financial strength rating, for which Cadence receives an 8 out of 10 score, is based on five ratios/scores (the higher-the-better for the first four and the lower-the-better for the fifth):
- Interest coverage ratio: 45.82, meaning the company generates enough operating income to pay its interest expenses 45.82 times over. In turn, that means the company is in no danger of defaulting on its debts.
- Altman Z-Score: 19.26, indicating the company is near the top of the Safe Zone and in no danger of bankruptcy.
- Equity-to-asset ratio: 0.63, which is calculated by dividing total stockholder’s equity by the total assets. Cadence has equity of $2.74 billion and total assets of $4.38 billion.
- Cash-to-debt ratio: 2.40, meaning the company has nearly two-and-a-half times as much cash, cash equivalents and marketable securities as debt.
- Debt-to-revenue ratio: For fiscal 2021, the company had $348 million in long-term debt (it has no short-term debt) and revenue of $3 billion. Dividing 348 by 3 billion will produce a very small number, which is what investors want to see.
Momentum
Using what’s known as the traditional momentum ratio (as opposed to residual momentum), each stock gets a score based on the average performance in two periods, 12 months ago to one month ago and six months ago to one month ago, divided by the beta of the stock over the past year.
Cadence is ranked a full 10 out of 10, which is, of course, high momentum.
GF Value rank
On the Summary page for each stock, you will find a revised table, the GF Value rank (formerly valuation). The table provides many familiar ratios, such as price-earnings, price-book and price-sales. It also includes less commonly used ratios, including price-to-free cash flow and enterprise value/Ebitda.
GuruFocus states, “The GF value rank is determined by the price-to-GF Value (P/GF Value) ratio, a proprietary metric calculated based on historical multiples along with an adjustment factor based on a company’s past returns and growth and future estimates of the business’ performance.”
It also advises that investors should avoid the most and least expensive stocks and stick with those in the middle. In addition, it reports that investors can be “more tolerant” of valuation.
Cadence receives a value rank of 5 out of 10, presumably a good ranking.
Conclusion
Cadence Design Systems deserves to have one of the highest rankings available. As we’ve seen, it scores full marks for profitability, growth and momentum, as well as good rankings for financial strength and value.
These are all constituents of quality companies, ones that investors can buy and hold for the short, medium and long term.
Cadence will interest growth investors looking for above-average capital gains without undue risk. Value investors might also pay attention because of its small debt load and the recent retreat of the share price. It does not pay a dividend, so income investors need to look elsewhere.
