Analog Devices trades at $204.41 per share and has moved almost in lockstep with the market over the last six months. The stock has lost 7.3% while the S&P 500 is down 5.8%. This might have investors contemplating their next move.
Is there a buying opportunity in Analog Devices, or does it present a risk to your portfolio? Dive into our full research report to see our analyst team’s opinion, it’s free.
Why Is Analog Devices Not Exciting?
Despite the more favorable entry price, we're swiping left on Analog Devices for now. Here are three reasons why we avoid ADI and a stock we'd rather own.
1. Revenue Tumbling Downwards
Long-term growth is the most important, but short-term results matter for semiconductors because the rapid pace of technological innovation (Moore's Law) could make yesterday's hit product obsolete today. Analog Devices’s recent performance marks a sharp pivot from its five-year trend as its revenue has shown annualized declines of 13.8% over the last two years. 
2. Shrinking Operating Margin
Operating margin is an important measure of profitability as it shows the portion of revenue left after accounting for all core expenses – everything from the cost of goods sold to advertising and wages. It’s also useful for comparing profitability across companies with different levels of debt and tax rates because it excludes interest and taxes.
Looking at the trend in its profitability, Analog Devices’s operating margin decreased by 8.1 percentage points over the last five years. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability. Its operating margin for the trailing 12 months was 20.8%.
3. Previous Growth Initiatives Haven’t Impressed
Growth gives us insight into a company’s long-term potential, but how capital-efficient was that growth? A company’s ROIC explains this by showing how much operating profit it makes compared to the money it has raised (debt and equity).
Analog Devices historically did a mediocre job investing in profitable growth initiatives. Its five-year average ROIC was 6.2%, somewhat low compared to the best semiconductor companies that consistently pump out 35%+.
Final Judgment
Analog Devices isn’t a terrible business, but it doesn’t pass our quality test. Following the recent decline, the stock trades at 26.6× forward P/E (or $204.41 per share). At this valuation, there’s a lot of good news priced in - we think there are better opportunities elsewhere. We’d suggest looking at a dominant Aerospace business that has perfected its M&A strategy.
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