Is Cirrus Logic, Inc. Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Cirrus Logic (NASDAQ: CRUS  ) fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell Cirrus' story, and we'll be grading the quality of that story in several ways:

  • Growth: Are profits, margins, and free cash flow all increasing?
  • Valuation: Is share price growing in line with earnings per share?
  • Opportunities: Is return on equity increasing while debt to equity declines?
  • Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's take a look at Cirrus' key statistics:

CRUS Total Return Price Chart

CRUS Total Return Price data by YCharts.

Passing Criteria

3-Year* Change

Grade

Revenue growth > 30%

93.3%

Pass

Improving profit margin

(72.5%)

Fail

Free cash flow growth > Net income growth

218.5% vs. (46.9%)

Pass

Improving EPS

(41.6%)

Fail

Stock growth (+ 15%) < EPS growth

10.1% vs. (41.6%)

Fail

Source: YCharts. *Period begins at end of Q1 2011.

CRUS Return on Equity (TTM) Chart

CRUS Return on Equity (TTM) data by YCharts.

Passing Criteria

3-Year* Change

Grade

Improving return on equity

(73.4%)

Fail

Declining debt to equity

No debt

Pass

Source: YCharts. *Period begins at end of Q1 2011.

How we got here and where we're going
We looked at Cirrus Logic last year, and it has slipped from its strong 2013 performance by two metrics in its second assessment to finish with only three out of seven possible passing grades. The company's profit margins have cratered since last year, which has dented (to put it mildly) net income and return on equity growth during our most recent three-year tracking period. However, Cirrus' free cash flow has soared since our previous assessment, and this metric is now nearly twice the size of Cirrus' net income. Will Cirrus be able to ride its key supply relationship with Apple (NASDAQ: AAPL  ) to a bottom-line rebound, and possibly a rare perfect score, by the next time we put it through its paces? Let's dig a little deeper to find out.

Cirrus has consistently bested analyst forecasts since late 2011, which represents a strong reversal of fortunes after the company disappointed Wall Street for several quarters in a row in 2010 and 2011. However, the company isn't out of the woods today, and it could still witness a major correction on its top and bottom lines as stiff smartphone competition between Apple and Android-based manufacturers slows Apple's torrid growth to a crawl. Motley Fool Technology specialist Ashraf Eassa points out that Cirrus remains highly dependent on Apple, as roughly 85% of its total revenue came from supplying Apple in its last quarter. This dependence exposes Cirrus to the well-known risks associated with businesses concentrated on a few big customers. Cirrus is aware of this problem and has been planning to diversity its operations by targeting other smartphones manufacturers.

Cirrus' most important effort in this direction was its recent acquisition of British-based Wolfson Microelectronics for $489 million, which bolsters its competitive position and gives it a foothold in Samsung's products. Wolfson has supplied audio chips for various Samsung smartphones and tablets, including the flagship Galaxy line, which has been one of the few smartphone brands to challenge the iPhone's dominance in recent years. Cirrus' acquisition also allows it to benefit from rising interest in wearable technology. According to an ABI Research report, major global tech companies should deliver more than 485 million wearable computing devices by 2018, and Wolfson's technology should only enhance Cirrus' capabilities in these devices. Since it only has about $300 million in cash on hand, Cirrus plans to raise about $225 million to fund the acquisition, which is expected to close in the second half of the 2014 fiscal year. This is bound to cost currently debt-free Cirrus a passing grade next year, but the hope is that Wolfson produces enough growth to offset these solvency issues.

Although Cirrus is determined to diversify, Apple is still far too important to its fortunes to ignore or minimize. Even after its acquisition, Cirrus will continue to derive roughly two-thirds of its revenue from Apple. Foolish writer Mukesh Baghel points out that the company should benefit from growth in Apple's iPhone unit sales, as Apple plans to add two larger-screened iPhones to its product line this year. According to China Economic Daily News, Apple will manufacture an estimated 80 million new iPhones this year, and these will, of course, come with Cirrus' hardware inside. However, Cirrus lost an amplifier supply role for Apple's iPad to Maxim Integrated Products, which shows that the company's position is far from infallible.

Putting the pieces together
Today, Cirrus Logic has some of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.

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