Power management chipmaker Dialog Semiconductor (NASDAQOTH:DLGNF), which depended on Apple (NASDAQ:AAPL) for approximately three-quarters of its revenue in 2016, recently made some comments that understandably shook investors.
Although Dialog management said on its most recent earnings call (via Reuters) that it expects to continue supplying Apple with power management chips for the current product cycle as well as for "2019-type products," the company conceded that "Apple has the resources and capability to internally design a [power management integrated circuit] and could potentially do so in the next few years."
Unsurprisingly, investors aren't exactly thrilled at the prospect of Dialog potentially losing such a critical customer (consider what happened to fellow Apple supplier Imagination Technologies), so the stock shed about 25% of its value during the Dec. 4 trading session.
This isn't the first time this fear has surfaced this year, either, which is why the shares are down, as Reuters says, about 50% this year.
The question worth asking now is this: Are Dialog Semiconductor shares, after such a substantial drop in value, now worth buying?
The case against Dialog Semiconductor
Right now, I see two possible near- to medium-term outcomes for Dialog Semiconductor. Either it keeps winning spots inside of Apple products but continually faces the looming prospect of Apple ultimately designing Dialog's chips out of its devices, or it loses critical spots inside of Apple's products and is ultimately forced to sell itself.
This means that, at best, Dialog's shares would trade at an extremely low multiple to earnings with possible earnings multiple contraction even if it continues to grow earnings -- leading to, at best, a stagnant stock price.
In the worst case, Apple designs Dialog Semiconductor out, Dialog's shares plunge even further from where they stand today, and then eventually the stock price gets a slight bump once Dialog sells itself.
Buying Dialog Semiconductor stock right now seems almost like the very definition of trying to, as the saying goes, pick up pennies in front of a steamroller.
Not all Apple supplier stocks are toxic
I don't want to give the impression that investors shouldn't seriously consider buying shares of Apple suppliers in general. Some of them can be good investments.
The key, though, is to pick suppliers that aren't entirely dependent on Apple revenue for their very survival -- at least if you don't want to run the risk of substantial losses on your investment. In very rare cases, there exist Apple suppliers that are heavily dependent on Apple but develop such unique technology/products that Apple wouldn't be able to replicate the technology or wouldn't be able to move orders to an alternate supplier.
An example of a strong Apple supplier is contract chip manufacturer Taiwan Semiconductor Manufacturing Company (NYSE:TSM). TSMC had a large, highly profitable, and ultimately successful business before Apple came along, and it could withstand the loss of significant Apple business if it came down to it (and it did come down to it during the iPhone 6s cycle).
Moreover, it would probably be near impossible at this point for Apple to develop the technology and institutional know-how to craft its own competitive cutting-edge chip manufacturing technologies from scratch.
It's also important to note that market dynamics change over time. A supplier that may have been safe four or five years ago might not be anywhere near as safe now, as Apple has boosted its in-house technology development capabilities.
Investing in Apple suppliers, especially ones whose businesses live and die by their ability to continue to win Apple business, isn't easy nor is it for the faint of heart. Tread carefully!
Find out why Apple is one of the 10 best stocks to buy now
Motley Fool co-founders Tom and David Gardner have spent more than a decade beating the market. (In fact, the newsletter they run, Motley Fool Stock Advisor, has tripled the market!*)
Tom and David just revealed their ten top stock picks for investors to buy right now. Apple is on the list -- but there are nine others you may be overlooking.
*Stock Advisor returns as of December 4, 2017
- What to Watch When Apple Reports Earnings on Nov. 1
- Apple Announces October Event: What to Expect
- Apple's iPhone XR Could Drive Record Unit Volumes in Fourth Quarter
- Apple Earnings: The Most Important Metric to Watch
- We Now Know How Apple Plans to Challenge Netflix and Amazon
Ashraf Eassa has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.