The NASDAQ's recent decline after its strong start to 2021 shows some growth investors were ready to dump pricey tech stocks and book their profits at the first sign of a shift in the macroeconomic winds. But that hasn't been the case among shareholders of Synaptics (NASDAQ:SYNA).
Shares of the human-interface solutions specialist have more than doubled over the past year, and they're up 42% in 2021. Indeed, the stock has taken off in recent weeks, even as the broader market stumbled. Let's take a look at the reasons why that may be the case and consider whether Synaptics has room to run higher.
Fatter margins are supercharging Synaptics' bottom line
The biggest factor working in Synaptics' favor is its shift toward a higher-margin business model. It reported a non-GAAP gross margin of 52.1% for its fiscal 2021 second quarter, which ended on Dec. 26. That was the highest adjusted gross margin level in the company's history and a big jump over the year-ago figure of 42.9%.
Synaptics produces an array of tech hardware components and software products, many of which sit at the human-machine interface. But its recent margin gains are the result of a shift in the product mix that the company initiated around three years ago.
Synaptics' guidance indicates it is on track to deliver more margin gains. The company anticipates a non-GAAP gross margin of 52.5% in the current quarter (at the midpoint), which would again be a big jump over the prior-year period's 44.1%. Not surprisingly, its earnings are expected to shoot higher in the coming years, increasing substantially over fiscal 2020's adjusted earnings of $5.95 per share.
What's driving the increased profitability?
The Internet of Things (IoT) business is playing a critical role in boosting Synaptics' margins. The company expects this segment to produce 43% of its total revenue in the third quarter of fiscal 2021, which would be nearly twice the prior-year period's contribution of 22%. The IoT business recorded 74% year-over-year revenue growth last quarter as new sales programs ramped up.
Synaptics expects its IoT business to sustain its terrific pace of growth and deliver higher profits. Management said on the latest earnings call it expects "the overall market for IoT will continue to grow at a 10% to 15% CAGR for the next few years." However, the company is confident it will be able to grow revenue at a faster pace than the overall market based on its prior design wins and the potential for market share gains.
According to CFO Dean Butler:
With our long-term target of IoT contributing more than half of our total revenue, we believe our long-term non-GAAP gross margins can further improve to 57% over time, and our non-GAAP operating margins can reach an industry-leading 30%.
Synaptics is making notable progress toward these goals, having scored multiple design wins across different IoT verticals. For instance, more than 13 automotive OEMs (original equipment manufacturers) are lined up to use Synaptics chips. A "premium SUV from one of the big three U.S. automakers" outfitted with Synaptics chips has already hit the market, and more are expected to be launched in the coming years.
On the other hand, Synaptics believes its revenue run rate from "home automation, smart displays, thermostats, smartwatches, drones, home surveillance and streaming devices" can double within the next year and keep growing in the long run.
So this impressive IoT momentum should ensure strong revenue and earnings growth. However, that's not the only reason why you should consider buying the stock.
Some more reasons to invest
Synaptics will also enjoy a tailwind from the rising demand for smartphones built around OLED (organic light-emitting diode) displays. The mobile device business is expected to account for 27% of total revenue this quarter, and it looks all set for a bumper year thanks to its relationship with Apple.
The company has provided enough indications that it's supplying OLED touch controllers for the Apple iPhone 12 lineup, and that's going to be a big growth driver going forward. Demand for the iPhone 12 is so strong Apple has had to reportedly increase its build orders for its flagship devices substantially.
As you can see, Synaptics has multiple levers it can pull to boost revenue and earnings -- throw in the fact that the stock was already trading at a relatively attractive valuation, and it becomes clear why shares withstood the tech industry sell-off. Synaptics trades at 34 times trailing earnings, while its forward price-to-earnings ratio of 18 reflects the potential for serious bottom-line growth in the coming year.
Compare those figures to its five-year average P/E multiple of 95, and it's clear that it doesn't make sense to sell Synaptics now, despite its strong rally over the past year. The stock still has room to deliver more upside, which is why investors looking for IoT stocks to add to their portfolios should take a closer look at Synaptics.