Over the past six months, Power Integrations has been a great trade, beating the S&P 500 by 20.9%. Its stock price has climbed to $61.57, representing a healthy 34.1% increase. This was partly due to its solid quarterly results, and the run-up might have investors contemplating their next move.
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Why Do We Think Power Integrations Will Underperform?
We’re happy investors have made money, but we’re passing on Power Integrations for now. Here are three reasons why there are better opportunities than POWI, plus one stock we’d rather own.
1. Revenue Spiraling Downwards
Examining a company’s long-term performance can provide clues about its quality. Any business can put up a good quarter or two, but many enduring ones grow for years. Over the last five years, Power Integrations’s demand was weak and its revenue declined by 6.4% per year. This wasn’t a great result and signals it’s a low quality business. Semiconductors are a cyclical industry, and long-term investors should be prepared for periods of high growth followed by periods of revenue contractions.
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.
Analyzing the trend in its profitability, Power Integrations’s operating margin decreased by 24.7 percentage points over the last five years. Power Integrations’s performance was poor no matter how you look at it - it shows that costs were rising and it couldn’t pass them onto its customers. Its operating margin for the trailing 12 months was 3.4%.
3. EPS Trending Down
We track the long-term change in earnings per share (EPS) because it highlights whether a company’s growth is profitable.
Sadly for Power Integrations, its EPS declined by 14.1% annually over the last five years, more than its revenue. This tells us the company struggled because its fixed cost base made it difficult to adjust to shrinking demand.
Final Judgment
Power Integrations doesn’t pass our quality test. With its shares topping the market in recent months, the stock trades at 37.5× forward P/E (or $61.57 per share). At this valuation, there’s a lot of good news priced in - we think other companies feature superior fundamentals at the moment. We’d recommend looking at one of our top digital advertising picks.
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