One of the biggest losers as of today's morning session is semiconductors company ON Semiconductor, whose shares are down -3.1%, underperforming the Nasdaq by -2.0%.
At $76.76, ON is 17.02% below its average analyst target price of $92.5.
The average analyst rating for the stock is buy. ON underperformed the S&P 500 by -3.0% so far today, but outpaced the index by 50.0% over the last year with a return of 43.0%.
ON Semiconductor Corporation provides intelligent sensing and power solutions in the United States and internationally. The company is a technology company. Valuations in the technology sector are often very high, as investors are willing to overlook gaps in the fundamentals if they believe a company’s innovations can dominate or create new markets.
ON Semiconductor's trailing 12 month P/E ratio is 18.0, based on its trailing EPS of $4.27. The company has a forward P/E ratio of 14.9 according to its forward EPS of $5.16 -- which is an estimate of what its earnings will look like in the next quarter. As of the first quarter of 2023, the average Price to Earnings (P/E) ratio of US technology companies is 27.16, and the S&P 500 average is 15.97. The P/E ratio consists in the stock's share price divided by its earnings per share (EPS), representing how much investors are willing to spend for each dollar of the company's earnings. Earnings are the company's revenues minus the cost of goods sold, overhead, and taxes.
We can take the price to earnings analysis one step further by dividing the P/E ratio by the company’s projected five-year growth rate, which gives us its Price to Earnings Growth, or PEG ratio. This ratio is important because it allows us to identify companies that have a low price to earnings ratio because of low growth expectations, or conversely, companies with high P/E ratios because growth is expected to take off.
ON Semiconductor's PEG ratio of 1.03 indicates that its P/E ratio is fair compared to its projected earnings growth. In other words, the company’s valuation accurately reflects its estimated growth potential. The caveat, however, is that these growth estimates could turn out to be inaccurate.
To understand a company's long term business prospects, we must consider its gross profit margins, which is the ratio of its gross profits to its revenues. A wider gross profit margin indicates that a company may have a competitive advantage, as it is free to keep its product prices high relative to their cost. After looking at its annual reports, we obtained the following information on ON's margins:
| Date Reported | Revenue ($ k) | Cost of Revenue ($ k) | Gross Margins (%) | YoY Growth (%) |
|---|---|---|---|---|
| 2022-12-31 | 8,326,200 | 4,249,000 | 48.97 | 21.6 |
| 2021-12-31 | 6,739,800 | 4,025,500 | 40.27 | 23.34 |
| 2020-12-31 | 5,255,000 | 3,539,200 | 32.65 | -8.72 |
| 2019-12-31 | 5,517,900 | 3,544,300 | 35.77 | n/a |
- Average gross margin: 39.4%
- Average gross margin growth rate: 8.2%
- Coefficient of variability (higher numbers indicating more instability): 18.0%
We can see from the above that ON Semiconductor business is not strong and its stock is likely not suitable for conservative investors.
ON Semiconductor's financial viability can also be assessed through a review of its free cash flow trends. Free cash flow refers to its operating cash flows minues its capital expenditures, which are expenses related to the maintenance of fixed assets such as land, infrastructure, and equipment. Over the last four years, the trends have been as follows:
| Date Reported | Cash Flow from Operations ($ k) | Capital expenditures ($ k) | FreeCashFlow ($ k) | YoY Growth (%) |
|---|---|---|---|---|
| 2022-12-31 | 2,633,100 | -1,036,000 | 1,597,100 | 23.81 |
| 2021-12-31 | 1,782,000 | -492,000 | 1,290,000 | 221.94 |
| 2020-12-31 | 884,300 | -483,600 | 400,700 | 566.72 |
| 2019-12-31 | 694,700 | -634,600 | 60,100 | n/a |
- Average free cash flow: $836,975,000.00
- Average free cash flow growth rate: 127.0%
- Coefficient of variability (lower numbers indicating more stability): 86.6%
Free cash flows represents the amount of money that is available for reinvesting in the business, or paying out to investors in the form of a dividend. With a positive cash flow as of the last fiscal year, ON is in a position to do either -- which can encourage more investors to place their capital in the company.
Another valuation metric for analyzing a stock is its Price to Book (P/B) Ratio, which consists in its share price divided by its book value per share. The book value refers to the present liquidation value of the company, as if it sold all of its assets and paid off all debts. As of the first quarter of 2023, the average P/B ratio for technology companies is 6.23. In contrast, the average P/B ratio of the S&P 500 is 2.95. ON Semiconductor's P/B ratio is 5.4, telling us that the market value of the company exceeds its book value by a factor of 5, but is still below the average P/B ratio of the Technology sector.
As of first quarter of 2023, ON Semiconductor is likely undervalued because it has a lower P/E ratio than its sector average, an average P/B ratio, and a pattern of improving cash flows with an upwards trend. We hope this analysis will inspire you to do your own research into ON's fundamental values -- especially their trends over time.
