It happened again. Last night, Wall Street's Wise Men agreed with me that semiconductor-design software maker Synopsys's (Nasdaq: SNPS) stock is too expensive. So why am I not smiling? Because they're right for the wrong reasons.
The evening news
Five minutes after yesterday's close of trading, Synopsys reported earnings. On one hand, the numbers bested estimates handily; on the other, they promised bad news in the current quarter; and on the third (wait, third?) hand, they reassured investors that everything is on track, long-term.
Second-quarter sales rose 7% year over year to $292.9 million. Net earnings nearly octupled, with a litigation settlement payment from Magma Design (Nasdaq: LAVA) boosting net income to $41.3 million, or $0.28 per share. Even without the settlement, we'd still be looking at a quintupling of profits here. So what's not to like?
Wall Street myopia
Well, for one thing, Synopsys lagged analysts' profit expectations for the current, third fiscal quarter by $0.02 per share. For another, an analyst downgrade this morning probably also contributed to the stock's 10% drop. As for what else is driving the sell-off -- well, there should be something. A prediction and an opinion seem awfully flimsy grounds for knocking $350 million off a company's market cap.
But for the life of me, I can't figure out what that "something" might be. According to CEO Aart de Geus, "strong revenue and earnings growth and solid cash flow" in the second quarter now make it possible for Synopsys "to finish the year stronger than initially planned." So at the same time as Synopsys promised fewer profits (and only wishy-washy "pro forma" profits at that) in Q3, it raised its sights for the full fiscal year, promising to bring home as much as $1.205 billion in revenues, and to transform these into $0.78 to $0.89 in per-share profits -- real, honest-to-goodness GAAP profits, this time.
My dilemma
So here's the dilemma I face, writing about this mixed up mess. On the one hand, Wall Street shouldn't punish the stock for projecting a short-term shortfall as prelude to a longer-term windfall. That said, the stock should be sold for another reason: valuation.
Now, Synopsys went a ways toward granting my wish, expressed in Tuesday's Foolish Forecast, for improved free cash flow in Q2. Tripling its operating cash flow, the firm generated $118.1 million in cash profits year-to-date. It's now on track to both pass its stated goal of $275 million or more in annual cash from operations, and also beat my projected free cash flow estimate, by generating $236 million or so in cash profits. Problem is, with long-term profit growth projected at 12%, $236 million in free cash flow still doesn't support a market cap of 17 times that sum.
Wall Street is right to sell Synopsys, but it's doing so for the wrong reason.
Past synopses on Synopsys:
Fool contributor Rich Smith does not own shares of any company named above.
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