When you hear "tech stock," your first thought is probably "expensive." And that's generally the case. With stocks such as Travelzoo (NASDAQ:TZOO), Yahoo! (NASDAQ:YHOO), and Google (NASDAQ:GOOG) selling at triple-digit P/Es, it's certainly one pricey sector of the stock market.
But back up a minute and look at the tech subsector of semiconductor stocks. Motley Fool Stock Advisor pick Silicon Labs (NASDAQ:SLAB) is selling for a P/E of just 21 and industry standard Intel (NASDAQ:INTC) for just 20! Bargains? They look to be. And today, an even deeper discount appeared on this Fool's radar screen, in the form of chip design-software maker Synopsys' (NASDAQ:SNPS) fiscal 2004 earnings report.
Before we get to those numbers, let's look at the company's valuation. On the surface, with a P/E about halfway between Intel's and Silicon Labs', it looks only about as cheap as the kinds of companies that use its software. But look deeper, Fool, and you'll see a company with an enterprise value-to-free cash flow ratio of just half its P/E.
Intrigued? Great -- we'll look at the specifics in a sec. But first, let's see why Mr. Market so hates Synopsys' stock. According to the earnings report, in comparison to 2003, fiscal 2004 was a rough one for Synopsys. Revenues declined 7% to $1.1 billion year-on-year. And profits declined by more than half, ending the year at just $0.45 per diluted share.
As bad as 2004 was, however, Synopsys' predictions for fiscal 2005 make 2004's results look like Utopia. The company expects revenues to continue to decline by about 13% over the next 12 months. And as for profits, they could go missing completely -- although in the best case, Synopsys thinks it can earn up to $0.11 a share. Interestingly, if Synopsys's predictions pan out, then by next year the company will almost certainly reach the lofty valuations of its tech counterparts -- the hard way. Earnings of $0.11 a share against a stock price that at yesterday's closing bell had reached $18.64 would give Synopsys a P/E of 169.
Of course, it's more likely that Synopsys' price will fall as its bleak near future comes to pass, dropping its valuation into the double-digits. While the stock would still look pricey at half its current market cap, any significant drop in price should perhaps be viewed as a buying opportunity. Here's why: Synopsys sports an enterprise value of just $2.2 billion, but even in this difficult year, it generated $221 million in free cash flow. What's more, it has about $600 million banked to help it weather the cyclical semiconductor storm. One day not far off, I'd wager, Synopsys, at an EV/FCF of less than 10, is going to look awfully cheap.
For more views on Synopsys, read:
- Flush Five to Survive
- Subscription Software Is Sweet
- The MoSys Synopsys: A Rip-Off
- Synopsys' Q2 Surprises
Fool contributor Rich Smith owns no shares in any of the companies mentioned in this article.
