Shares of InvenSense (NYSE:INVN) are down 10% over the past year, underperforming rivals Analog Devices (NASDAQ:ADI), and STMicroelectronics (NYSE:STM). Owners of InvenSense stock might be loathe to eat their losses and sell the stock, but I think that's precisely the thing to do now. And I'll tell you why.
InvenSense stock costs too much
Even with that 10$ haircut, InvenSense stock remains the most expensive of the three big players in micro-electro-mechanical system, or MEMS, gyroscopes, which are used for motion-tracking functions in consumer electronics.
At a forward price-to-earnings ratio of 20, InvenSense stock sells for 20 times the profits the currently unprofitable company might earn next year. That makes the shares about 2.5% pricier than those of barely profitable STMicro, and 9% more expensive than cheapest of the bunch Analog Devices.
InvenSense stock has done the worst job of growing profits
Did I mention that InvenSense isn't profitable? That it posted operating losses for the past three quarters, and net losses for the past four?
Well, it has. As a result, InvenSense stock "boasts" the worst average earnings growth rate in this group of companies over the past five years:
And InvenSense just isn't churning out the cash
More important than the generally accepted accounting principles losses, in my view, is that InvenSense has struggled to produce the kind of cash it needs to grow its business and compete effectively with its better-performing rivals. The company's free cash flow -- which through the end of 2012 was pumping along pretty well -- has weakened of late, and is currently running negative. Indeed, according to data from S&P Capital IQ, operating cash flow has run negative in three of the past four quarters.
Let's take a quick look at how the company compares to its peers in the matter of free cash flow yield -- InvenSense's market capitalization (the price you pay for its stock) divided into its free cash flow (the money your investment generates for you):
As you can see, in contrast to steady-Eddie Analog Devices, which consistently churns out $0.04 or more worth of cash profit for every dollar you put into the stock, InvenSense has been consuming cash for about a year now. Even STMicro -- formerly a pretty poor performer -- is now outearning InvenSense from a cash profit perspective.
If things keep going as they have for InvenSense, there's little prospect of the company being able to reward its shareholders with a cash dividend (as both of its rivals already do). Lack of free cash flow will also make it difficult for InvenSense to finance stock buybacks (which increase the size of your stake in the company for every share taken off the table). Lack of internally generated cash could also starve the business of the capital it needs to reverse its negative trends and compete better with its rivals.
What it means to investors
Does this mean there's no hope at all for InvenSense? Not necessarily. In fact, of the three companies discussed above, InvenSense is increasing its sales fastest. It's also the one that analysts believe has the best chance of growing earnings quickly in the future. And InvenSense enjoys the support of many analysts at The Motley Fool, which recommends the stock.
All that being said, I personally am not convinced. If the trends I see at InvenSense -- weak support enthusiasm among investors, weak performance in profit production, and a high stock price in spite of all this -- continue, I think the stock's days are numbered.
That's why I think now is the time to sell InvenSense -- before the situation gets any worse.
Rich Smith has no position in any stocks mentioned. The Motley Fool recommends InvenSense. The Motley Fool owns shares of InvenSense. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.