Value investors are always on the lookout for companies which show strong revenue and earnings growth that trade at low earnings multiples. The identification of and subsequent investment in such companies can generate excellent returns for shareholders. But investors must be careful not to be fooled into thinking a company is growing its revenue and earnings when it is instead simply benefiting from cyclical trends.
For example, consider Kulicke and Soffa Industries (KLIC), which provides capital equipment to semiconductor manufacturers. As a leader in this space, the company has a lot going for it. Revenue and earnings rose through the roof this year, as customers expanded and modernized their manufacturing capabilities. As KLIC is in the process of moving facilities from the US to Asia, it stands to benefit from cost reductions that could increase profits even more.
The company is also a technology leader among its peers; for example, KLIC's R&D efforts have resulted in a commercially viable bonding process using copper wire instead of gold, which reduces customer costs. (Though I suppose this might disappoint some end-users who would like to be able to use their semiconductor chips as currency when the apocalypse arrives.)
But while this is a strong company in a growing field, KLIC trades for a P/E of just 5, despite having more cash than it does debt! As such, on the surface this company looks like an absolute steal. But investors shouldn't ignore just how cyclical this business is. Consider the company's revenue and operating profit numbers over the last ten years ($ millions):
The cycles in this industry are obviously very intense and rather short, as revenue can double or half over the course of just one or two years, and it can do so several times in a single business cycle! This is because of KLIC's dominant "Equipment" segment, which derives its revenues from the capital expenditures of semiconductor manufacturers. These expenditures, in turn, are based on whether there is a need for industry expansion; if there isn't, demand for new equipment understandably plunges.
So while KLIC's recent and forward-looking numbers look great, its operating income has actually been negative over the period depicted in the chart above. Is that really "growth" the company is experiencing right now, or is the company just in a very favourable point in the cycle? Investors should be sure they know the difference before investing in this cheap-looking stock.
Disclosure: NoneThis article was written by Saj Karsan of Barel Karsan. If you enjoyed this article, please consider subscribing to the feed.
2 days ago
