Analog Devices

Selling shovels for Industry 4.0

Markets remain under pressure - young, highly future-oriented companies in particular that aren't really profitable yet have already corrected considerably. Take, for example, the Ark Innovation ETF, managed by economist Cathie Wood: it has already dropped more than 50 percent from its all-time high. It gets even more interesting when you compare this ETF with the Nasdaq 100 index from the years of the dot-com bubble. I've charted the whole thing here - the similarities are truly astonishing. I'm not saying it will happen again. But if there's one thing we can learn from history, it's that history tends to repeat itself.

Today I'd like to introduce an established, highly profitable and yet extremely innovative semiconductor company. Analog Devices Inc. is a global leader in, among other things, data conversion and signal processing technologies, which play a crucial role in the digitalization of industry. Let's take a closer look at this interesting shovel seller today.

The origins and business model of Analog Devices Inc.

The origins of today's semiconductor company go back to Raymond Stuart Stata, who was born on November 12, 1934, in the small farming community of Oxford (Pennsylvania). His father worked as a self-employed electrician. So it was no surprise that Ray, as he was usually called, developed an interest in technology early on. Without thinking twice, he decided after high school to become an engineer and to attend the Massachusetts Institute of Technology for that. Since he came from a far from wealthy family, he had to finance his studies by cleaning rooms on campus and helping out in the library. In 1958, Ray completed his master's degree in electrical engineering at MIT and started working in sales at the Hewlett-Packard Company, one of the most renowned technology companies of the time. There he was able to learn a lot about the industry and gain important experience, but he quickly realized that he wanted to start his own company.

In 1962, Ray left HP and, together with his two former classmates Matthew Lorber and Bill Linko, founded Solid State Instruments Inc. - a small company that mainly made equipment for testing gyroscopes. Business was actually rather sluggish, yet within the first year they received a takeover offer from the Kollmorgen Corporation. The three founders agreed, each received 50,000 US dollars, and committed to working there for another two years. Ray and Matthew were founders heart and soul and didn't hesitate long before forging plans for a new company. Searching for what they could make, they finally came across high-performance signal amplifiers - circuits for amplifying electrical signals. These were important components of analog devices and systems and enjoyed steadily growing demand. Still, signal amplifiers were a rather small niche market, and the competing products didn't really convince the two electrical engineers either. So they had found their market, and just a few days after the contract with Kollmorgen had expired, on January 18, 1965 to be exact, the two founded Analog Devices Inc..

Soon they hired the smart engineer Richard Burwen, who used his technical know-how to design the first operational amplifier models. These were significantly more powerful than those of the competition and therefore practically sold themselves. The young company was already profitable in its first fiscal year. It steadily developed new modules and enjoyed revenue increases of around 80 percent per year. Only four years after its founding, Analog Devices became the market leader in modular operational amplifiers with annual revenue of 8.7 million US dollars. To raise new capital, the company went public in March 1969. Shortly afterward came the first acquisition: Pastoriza Research, a manufacturer of special integrated circuits that could convert analog signals, such as pressure or temperature, into digital ones. The company continuously invested in developing new, innovative products and was thus able to grow nicely over the years. Today Analog Devices Inc. is one of the leading semiconductor companies in its segment and supplies its 125,000+ customers worldwide with more than 75,000 products.

How could Analog Devices develop in the future?

Before I get to that, I'd like to briefly summarize the business model of Analog Devices Inc. once more. The semiconductor company employs about 15,900 people in the development, manufacturing and marketing of analog, mixed-signal and digital signal processing circuits used in industrial, communications, computer and consumer applications. To put it a bit more simply: Analog Devices' products convert real-world phenomena such as temperature, pressure, sound, light, speed or motion into electrical signals. They build the bridge, so to speak, between the physical world and the computer world.

Now let's take a look at the numbers for the most recently reported quarter (Q4 2021 - ended October 30, 2021). Total revenue for the period from August to October 2021 came in at 2.34 billion US dollars, well above the result from the prior-year quarter. In Q4 2o2o, revenue was still 1.53 billion US dollars - so we have an increase of 53 percent here, driven mainly by strength in the two sales markets industrial and automotive. Adjusted profit rose from 636 million US dollars to now one billion US dollars. Last but not least, earnings per share also increased from 1.44 US dollars to 1.73 US dollars. I think these quarterly numbers are really impressive.

If you look at the revenue breakdown of Analog Devices Inc., you quickly see that we're really dealing with an industrial semiconductor company here. At 49 percent, this business segment is by far the most important. It's followed by the automotive segment, which contributes about 20 percent of revenue. 16 percent comes from products for communications and infrastructure solutions, and about 15 percent from various consumer applications. So it's no wonder that Industry 4.0 in particular has become an important growth driver. The fact is that more and more industrial companies are currently in the middle of the digital transformation and factories are being fundamentally modernized. In the future, intelligent machines will be able to coordinate manufacturing processes on their own, and robots will assist workers with heavy assembly tasks. Material flow could also largely be taken over by artificial intelligence in the future. With its offering, Analog Devices is undoubtedly very well positioned here.

Apart from that, the technology company will also be able to grow through acquisitions in the future. Most recently, it bought the semiconductor manufacturer Maxim Integrated, which allowed Analog Devices to further expand its position as a leading supplier of high-performance semiconductors. An acquisition always carries risks, but I'm confident that they're proceeding carefully here and know exactly what they're doing. All in all, I'm actually optimistic about the future of this semiconductor company.

What about the dividend?

Analog Devices investors received their first share of the company's profits in the form of dividends as early as 1975. However, the dividend hasn't been paid every year since then. Only since 2003 has the dividend been paid every year and also raised. Looking at the last 10 years, the semiconductor company has managed to raise its payout by an average of 10.0 percent per year. The current dividend yield of 1.6 percent is also quite respectable. The only thing I find a bit too high is the current payout ratio of 74.8 percent.

Conclusion:
At first, Analog Devices focused only on a small niche market, which it quickly came to dominate. Over the years, this grew into one of the leading semiconductor companies, known among other things for its high-performance data conversion technologies. I consider the business model promising and can easily imagine investors enjoying this stock for a long time to come.