What happened
Shares of Cadence Design Systems (CDNS 1.13%) fell 18.4% last month, according to data provided by S&P Global Market Intelligence. Many growth stocks started to experience some turbulence around Thanksgiving, but not Cadence -- at least not until January when the Federal Reserve hinted it was ready to start raising its benchmark interest rate this year in an effort to fight inflation.
Higher interest rates lower the present value of stocks, especially of growth companies. Thus, Cadence, which has been on an absolute tear since the start of 2020 (up 120% even after the sell-off), was due for a cool down.
Image source: Getty Images.
So what
Cadence occupies an interesting niche within the semiconductor industry. Though not a chip designer, it develops the software that chip companies use to develop the increasingly complex computing hardware we rely on every day. Given how small high-performance chips are these days, designs are simply too complicated for engineers to pencil out manually. So Cadence infuses machine learning -- a branch of artificial intelligence (AI) -- to help automate redundant processes and speed up development of new electrical circuitry.
Now add in a global chip shortage, and it's not too hard to see why Cadence's stock would be attracting so much attention over the last two years. However, unlike most companies in the semiconductor industry -- which are prone to cyclical sales swings based on supply and demand -- Cadence is what you would expect from a subscription software investment. A Cadence shareholder gets the growth of the chip industry, as computing becomes pervasive across all industries, but paired with the consistent financial numbers of a software-as-a-service (SaaS) business model.
Data by YCharts.
Now what
After the recent sell-off, Cadence shares now trade for 45 times trailing-12-month free cash flow. It's still a premium -- but not totally unwarranted -- price tag. For 2021's fourth quarter, management said to expect revenue of $745 million to $765 million compared to $760 million in revenue in Q4 2020. However, for full-year 2021, guidance implies an 11% growth rate, and operating profit margins are expected to increase to 26% compared to 24% the year prior.
If you're looking for a more steady bet on growth in the semiconductor industry, Cadence Design Systems is a rock solid business to give a close look.
