It still mostly doesn't come in on lists of top software-as-a-service (SaaS) stocks, but Synopsys (SNPS 2.56%) really should. Back in 2020, the market rerated the largest provider of semiconductor and artificial intelligence (AI) systems design tools for what was becoming an emergent growth trend, and Synopsys has barely looked back ever since. The stock has doubled over the last three years alone.
Even now, though, many investors have barely heard of Synopsys and its closest peer Cadence Design Systems. This is no "cheap" investment, but likely for good reason. This could be a sustainable growth stock for many years as chips and AI are in rapid expansion mode.
No one's making much progress without this software suite
In its latest quarter (Q3 fiscal 2023, the three months ended in July 2023), Synopsys said 65% of its $1.49 billion in revenue came from its core electronic design automation software business, or EDA. As is also the case with the other two dominant EDA players Cadence and Siemens (called Mentor before the German industrialist acquired it), EDA software isn't just for semiconductor companies anymore.
A fast-increasing number of computing system designers and operators, including those racing to fill up their data centers with generative AI (think Microsoft, Amazon, Meta Platforms, and the like) are also big Synopsys customers these days. Synopsys said its EDA sales grew 23% year over year as a result.
The other two primary segments -- design IP and software integrity -- comprised 25% and 10% of total revenue in the last quarter. Each of those segments only grew 12% year over year, although design IP is expected to have a strong finish to the fiscal year. Design IP involves the licensing of Synopsys chip patents to its customers. Software integrity was patched together via a handful of acquisitions in recent years and competes in the cybersecurity industry against businesses like Palo Alto Networks.
Focusing again on the core EDA segment, though, Synopsys has virtually every chip and AI system integrator business as a customer these days. Its highly complex and specialized software suite is an absolutely integral part of the IT industry and the emerging growth trend of generative AI. Early in 2023, Synopsys management said its Synopsys.ai software had reached 100 customers, but that number had swelled to over 270 in August.
Q3 fiscal 2023 was a great quarter for Synopsys, with overall revenue growing 19% year over year and adjusted earnings per share (EPS) growing 37%. Management upgraded full-year guidance and now anticipates revenue to grow as much as 15% compared to 2022, and adjusted EPS to grow as much as 25%.
Synopsys can win in any semiconductor sales environment
Synopsys' design and other related software and services have notched impressive growth over the last decade, all in a semiconductor industry known for some wild cyclical swings in demand. Such is the case for any manufactured product, and chips are no exception.
How does Synopsys do it? Chip designers, manufacturers, and computing system companies all need to keep engineering new innovation so they don't fall behind competitors, regardless of the end demand from their customers. Synopsys' software sales thus tend to hold steady as research and development budgets rise over time.
Data by YCharts.
A new era of AI is upon us, and it's being driven by companies around the world grappling with the need to do more with less -- be it human talent or computing and related physical infrastructure. AI can help solve some of these needs, making available resources go further. Synopsys is at the heart of these developments.
It's also utilizing AI itself. Synopsys.ai software was recently infused with some generative AI of its own to help engineers make quicker work of design layout problems and to verify chip designs have no errors before going to the manufacturing line. This is helping Synopsys meet its goal to not just grow, but to lift its operating profit margin by at least 100 basis points every year going forward. This year has been particularly good, with the company on track to increase its adjusted operating margin by 200 basis points, from 33% in 2022 to about 35% this year.
Synopsys carries a very high premium of 54 times expected current year EPS, or 39 times expected adjusted EPS. The valuation got a boost during the pandemic, and it could remain elevated as long as the market views this as a core business to the current AI secular growth trend (and for as long as AI sticks around as a solution to help businesses automate tasks). As such, many investors may want to pass on Synopsys stock, despite analyst expectations for double-digit percentage EPS growth for the foreseeable future.
But if you do decide to buy, this would be an ideal dollar-cost averaging candidate to take advantage of what is sure to be a bumpy ride -- typical for any premium-priced growth stock.
