The semiconductor industry has been one of the interesting segments of the Technology sector to watch for a few years now. Since 2016, the industry as measured by the iShares Semiconductor ETF (SOXX) has outpaced the rest of the broad stock market by a wide margin, increasing in value by more than 140%; by comparison, the S&P 500 increased by 60% over the same time period. Since hitting an all-time high in mid-March, however, the industry has stagnated, falling almost 8% as of this writing from that peak. Concerns about issues ranging from stagnating or even falling demand amid increasing supply levels to ongoing tensions about trade war between the U.S. and China in particular have kept investors on edge. They’ve also put a lot of pressure on some pretty well-known names in the industry, like Micron Technology (MU), Western Digital Corporation (WDC), and even the big boys like Intel Corporation (INTC),
One of the things about industry analysis is that when you dig into an industry, you naturally separate the big, established players from the smaller, less-visible, but equally important companies. Sometimes, when the big boys in the market struggle, better opportunities can be found by looking at some of those smaller players. These can be young, up-and-coming contenders, poised to become dominant players in the future of the industry; at other times, their smaller size is because they operate in a specific niche that might keep them from naturally growing much more than they already have; but their expertise and leadership in that niche makes them important contributors and catalysts to the broader industry’s long-term success. From an investment standpoint, these are small stocks that may not necessarily translate to the kind of high-growth potential that makes the talking heads on TV wag their tongues; but for a patient investor who is willing to focus on value, they can also represent an interesting, and useful way to diversify away from from the crowd.
FormFactor, Inc. (FORM) looks like an interesting example. This is a company that has been in business since 1993, providing a fairly narrow, but critically important set of testing equipment solutions for the global semiconductor industry. FORM has followed the general industry trend to drop from late March highs around $15.50 to their current level around $13; but that decline is significantly less than any of the other, bigger and better-known names I listed at the beginning of this article.
This is a small-cap stock with an established name, and a global list of customers that rely on their expertise to keep up with Moore’s Law – the name given to the observation made by Intel founder Gordon Moore in 1965 that the number of transistors in a dense integrated circuit doubles every two years or so. Since 2012, that pace has slowed, and it is true that this is an observed phenomenon more than a scientific fact, but it underscores the basic idea that technology never stops advancing or improving – in its ability to expand what it can do, or how efficiently it does it. FORM’s business is built around helping the semiconductor industry keep doing exactly that.
Fundamental and Value Profile
FormFactor, Inc. is a provider of test and measurement solutions. The Company’s segments include the Probe Cards segment and Systems segment. The Company designs, manufactures and sells multiple product lines, including probe cards, analytical probes, probe stations, integrated measurement systems, thermal sub-systems, reliability test systems, and related services. Its products provide electrical information from a range of semiconductor and electro-optical devices and integrated circuits (devices) from development to production. Probe Cards segment consists of probe card products and analytical probes. Systems segment consists of wafer probing, thermal and reliability products to enable precision on-wafer measurement of integrated circuits. Systems products are used in the early phases of the development and characterization of semiconductor processes. FORM’s current market cap is $956.5 million.
- Earnings and Sales Growth: Over the last twelve months, earnings decreased by 40%, while sales declined by a little less than 6%. In the most recent quarter, however earnings improved by more than 75%, while sales grew about 14.5%. Growing earnings faster than sales over any time period is hard to do, and generally isn’t sustainable in the long-term; however it is also a positive mark of management’s ability to maximize its business operations. FORM operates with a narrow margin profile; over the last twelve months, Net Income was 5.5% of Revenues. In the last quarter, improvement in this area is almost surely a contributor to the company’s improved earnings result, as Net Income increased to 6.7% of Revenues.
- Free Cash Flow: FORM’s free cash flow for the trailing twelve months is modest, but still generally healthy for their size, at a little more than $55 million. That translates to a Free Cash Flow Yield of 5.8%.
- Debt to Equity: FORM has a debt/equity ratio of .11. This is a very low number that demonstrates a very conservative approach to leverage. The company also has excellent liquidity, with more than $143 million in cash against only about $51 million in long-term debt.
- Dividend: Like most stocks in the tech sector, FORM does not pay a dividend.
- Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for FORM is $6.53 per share and translates to a Price/Book ratio of 2 at the stock’s current price. Their historical Price/Book average is 1.975, which means that if you adhere strictly to this number, the stock is fairly valued at its current level, with not a lot of upside potential remaining. This is where I think the “diamond in the rough” element comes into play, because if you look at the stock Price/Cash Flow ratio you get a much different view. The stock is is trading more than four times below its historical Price/Cash ratio, which suggests that the stock’s long-term price target could be in the $50 range. That’s well above the stock’s all-time high in the high $40’s, a level that hasn’t been seen since late 2007.
Here’s a look at the stock’s latest technical chart.
- Current Price Action/Trends and Pivots: Since March of this year, the stock has hovered in a fairly narrow price range, with resistance in the $14.50 to $15 level range, and support at around $12.50 per share. It’s true the stock has broken above and below that range on a couple of occasions; but those look more like outliers than momentum-changers. The gradually descending slope of resistance can be seen by the consistently lower pivot highs over the last few months, which is narrowing that trading range, and is more and more likely to suggest the stock is poised to break out of the current sideways trend to establish a new decisive trend.
- Near-term Keys: The stock is hovering around support, just a little below $13 per share as of this writing. A new push above $14.50, to $15 could provide an interesting signal for a bullish trading setup, either with call options or by buying the stock outright, while a drop below support to around $12 could be a warning sign that an even more extended decline could in store to test levels below $10 the stock hasn’t visited since 2016. If you like the stock’s fundamental strength, and are willing to accept some price volatility in the near to intermediate-term, this stock could prove to be an unexpected top performer in the semiconductor industry in the years ahead.