The last two years proved to be excellent for US equities, with total returns for the S&P 500 of 16% and 32.3%, respectively, for 2012 and 2013. However, this successful run has made investing for 2014 much more difficult. Profit margins, which are stretched to all time highs mainly from cutting expenditures and labor costs, will have a difficult time not rolling over without new revenue growth. Other popular valuation metrics, such as Warren Buffett's famous market value of stocks to GDP ratio, and the cyclically adjusted price-earnings multiple show that stocks are no longer cheap. This does not mean that we will have a market crash per se, but it is time to be more selective with the industries and stocks that we choose. High yielding stocks, such as utilities, are very expensive with a forward P/E of close to 15. Capital-intensive stocks, like companies in the basic materials and energy sectors, will continue to be held in check by various factors. Higher interest rates, a stronger dollar, and the continuing production of domestic energy will continue to keep materials and energy prices down.
In an investing environment described as the one above, I tend to look for an innovative company that has the potential to not be too correlated with the market. That will typically mean a technology, pharmaceutical or a biotech company that is on the verge of a breakthrough in a new market or underdeveloped market.
Synaptics Incorporated, SYNA
Synaptics (NASDAQ:SYNA) is a leading developer of human interface solutions and touch technology for smartphones, tablets, and other electronic devices. The demand for smartphones and tablets will continue to be robust for the next several years, with industry projections for the mobile smartphone market for the period 2013 through 2017 to have a compound annual growth rate of 13.4%, and a compound annual growth rate of 15.7% for the tablet market. The growth in these markets, in my opinion, is directly related to the users' preference for touchscreen abilities. The demand for touchscreens is in the early stages, and will make its way to more laptops, and potentially even household appliances and vehicles in the future.
Financials and Valuation
Looking at the income statement from last quarter, Synaptics had an excellent quarter by generating 75% year over year top line growth. The driver of revenue growth for this quarter was mainly due from a large portfolio of mobile phone products, as it accounted for 73% of the company's revenue and grew 152% year over year. The large percentage of growth from mobile phone products is evidence of the trend I described above, as mobile phone products accounted for 49% and 64% of revenue for 2012 and 2013, respectively. Synaptics was also able to increase their gross margins by 130 basis points year over year, mainly from a reduction in compensation and headcount. Next quarter, which reports on January 23, management expects gross margins to slightly decrease to a range between 47% and 48%, and revenue to slightly decrease as well to a range between $192 million and $208 million. Taking a look at the balance sheet, Synaptics is in very good shape with $332 million in cash and very little long-term debt. From a valuation standpoint, Synaptics PEG ratio of 1.85 is lower than the industry average of 1.99. Synaptics also has a lower forward P/E and P/C ratio than two of their main competitors, Atmel Corporation and Cypress Semiconductor. Given Synaptics and their competitors' respective growth rates in the coming years, it looks like Synaptics has an excellent opportunity to continue their run through 2014.