- By GF Value
The stock of Cadence Design Systems (NAS:CDNS, 30-year Financials) gives every indication of being significantly overvalued, according to GuruFocus Value calculation. GuruFocus Value is GuruFocus' estimate of the fair value at which the stock should be traded. It is calculated based on the historical multiples that the stock has traded at, the past business growth and analyst estimates of future business performance. If the price of a stock is significantly above the GF Value Line, it is overvalued and its future return is likely to be poor. On the other hand, if it is significantly below the GF Value Line, its future return will likely be higher. At its current price of $132.58 per share and the market cap of $37 billion, Cadence Design Systems stock appears to be significantly overvalued. GF Value for Cadence Design Systems is shown in the chart below.
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CDNS 15-Year Financial Data
The intrinsic value of CDNS
Peter Lynch Chart of CDNS
Because Cadence Design Systems is significantly overvalued, the long-term return of its stock is likely to be much lower than its future business growth, which averaged 11.4% over the past three years and is estimated to grow 9.29% annually over the next three to five years.
Investing in companies with poor financial strength has a higher risk of permanent loss of capital. Thus, it is important to carefully review the financial strength of a company before deciding whether to buy its stock. Looking at the cash-to-debt ratio and interest coverage is a great starting point for understanding the financial strength of a company. Cadence Design Systems has a cash-to-debt ratio of 2.02, which is in the middle range of the companies in Software industry. GuruFocus ranks the overall financial strength of Cadence Design Systems at 7 out of 10, which indicates that the financial strength of Cadence Design Systems is fair. This is the debt and cash of Cadence Design Systems over the past years:
It poses less risk to invest in profitable companies, especially those that have demonstrated consistent profitability over the long term. A company with high profit margins is also typically a safer investment than one with low profit margins. Cadence Design Systems has been profitable 10 over the past 10 years. Over the past twelve months, the company had a revenue of $2.7 billion and earnings of $2.11 a share. Its operating margin is 24.41%, which ranks better than 92% of the companies in Software industry. Overall, GuruFocus ranks the profitability of Cadence Design Systems at 9 out of 10, which indicates strong profitability. This is the revenue and net income of Cadence Design Systems over the past years:
Growth is probably the most important factor in the valuation of a company. GuruFocus research has found that growth is closely correlated with the long term stock performance of a company. A faster growing company creates more value for shareholders, especially if the growth is profitable. The 3-year average annual revenue growth of Cadence Design Systems is 11.4%, which ranks in the middle range of the companies in Software industry. The 3-year average EBITDA growth rate is 20.9%, which ranks better than 66% of the companies in Software industry.
Another method of determining the profitability of a company is to compare its return on invested capital to the weighted average cost of capital. Return on invested capital (ROIC) measures how well a company generates cash flow relative to the capital it has invested in its business. The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets. When the ROIC is higher than the WACC, it implies the company is creating value for shareholders. For the past 12 months, Cadence Design Systems's return on invested capital is 20.32, and its cost of capital is 7.66. The historical ROIC vs WACC comparison of Cadence Design Systems is shown below:
In summary, the stock of Cadence Design Systems (NAS:CDNS, 30-year Financials)gives every indication of being significantly overvalued. The company's financial condition is fair and its profitability is strong. Its growth ranks better than 66% of the companies in Software industry. To learn more about Cadence Design Systems stock, you can check out its 30-year Financials here. To find out the high quality companies that may deliever above average returns, please check out GuruFocus High Quality Low Capex Screener. This article first appeared on GuruFocus.