Why Selling This Stock Is Not a Good Idea

The New Year hasn't been a happy one for diversified semiconductor company Analog Devices (NASDAQ: ADI  ) . The stock was hit with a downgrade by Wells Fargo analyst David Wong on just the second day of the New Year. Wong cut his rating from "outperform" to "market perform," citing Analog Devices' fair valuation and balanced risk-reward profile, despite being optimistic about the semiconductor industry's outlook this year.

Also, Analog Devices' outlook for the ongoing quarter wasn't up to expectations when it had released its results in late November last year. The company expects seasonality to hurt business in the current period, similar to what industry peer Texas Instruments (NASDAQ: TXN  ) had said the last time it reported earnings.

However, considering the robust prospects in end-markets such as automotive, industrial, and communications, it won't be right to sell off Analog Devices straightaway. The stock had appreciated close to 25% in 2013, which might not look very impressive at first, given the market's terrific performance last year. However, Analog's enticing 2.70% dividend yield and well-diversified business are key points that investors shouldn't ignore.

Positive signs ahead
Analog Devices is optimistic about its end markets. In industrial, management believes that Analog's high-performance signal processing technology and system domain knowledge should help it gain more customers.  The company is counting on growth in various areas such as factory automation, connected and intelligent systems, and health care. This view is supported by semiconductor industry executives, who believe that sectors such as medical devices and industrial machinery are positioned for growth going forward, according to KPMG's annual global semiconductor industry outlook. 

Turning toward the automotive segment, Analog has seen solid growth here. Revenue from the segment was up 19% year-over-year in the last quarter, which is not surprising, considering strong vehicle sales in the U.S. last year. The company saw strong demand for chips used in various areas such as infotainment, safety, and powertrain. Analog Devices expects further tailwinds going forward, as new-generation infotainment systems gain ground and the safety aspect improves.  

Moreover, a look at the forecast for auto sales in 2014 also indicates that Analog's automotive segment is very likely to improve. According to Edmunds.com, vehicle sales are expected to rise to 16.4 million units in the U.S. this year, up from 15.6 million units last year.  

The global forecast is also quite encouraging, with IHS forecasting 85 million units this year, up from around 82 million last year. By 2018, global sales are expected to exceed 100 million. Thus, the long-term forecast for the auto industry looks appealing, and this could be an important driver for Analog Devices.

Communications to get better
Analog Devices should also see good growth in its communications infrastructure business. The 4G build-out by China Mobile (NYSE: CHL  ) , a recovering European communications market, and capacity improvements by carriers in the U.S. are expected to assist growth going forward, according to management.  

For instance, China Mobile has been building the first 4G network in the country. The telecom giant is expected to spend $13.5 billion on the 4G roll out this year, and reports suggest that it intends to cover more than 350 cities with its 4G network by the end of the year. China Mobile is planning to build more than 500,000 base stations, as it aggressively rolls out the network, leading to stronger demand for Analog Devices' chips. 

In line with industry trends
Hence, all is not lost for Analog Devices and it certainly doesn't make sense to sell the stock in a year when the semiconductor industry is expected to perform well. While it's true that Analog's outlook was not up to the mark last time, and its book-to-bill ratio was also below 1, this is a pattern seen across the industry.  

For example, bellwether Texas Instruments also had a book-to-bill ratio of less than 1 in the previous quarter and issued a weak outlook. Texas Instruments blamed seasonality for its tepid guidance, much like Analog Devices. However, even Texas Instruments should benefit from the various tailwinds that Analog Devices has going forward, and the stock's forward P/E of 20 against the trailing P/E of 25.5 suggests that earnings growth can be expected in the future.

The bottom line
Analog Devices is not in a crisis. The company issued one weak outlook, but that was because of overall weakness in the semiconductor industry last quarter. However, there are signs that the semiconductor industry should improve going forward, driven by applications in different areas such as industrial, automotive, and communications. As such, investors should continue holding Analog Devices due to its diversified business and dividend yield.

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