Analog Devices Signals A Top For Semiconductor Stocks

Key Points

• Analog Devices had a good quarter, but tepid guidance has shares moving lower. 
• The analysts support the stock but may lower their targets now that guidance is in. 
• The capital returns are safe and sideways trading will allow investors to build positions. 

Analog Devices NASDAQ: ADI has been leading the semiconductor market; now, the top is in. The FQ2 results were good enough, but the Q3 guidance is weak and suggests a downturn is coming for the industry. The latest upswing in prices is driven by hopes and hype surrounding the AI market, not industry growth. The semiconductor industry is contracting due to an inventory reset compounded by weakened consumer demand that will persist through the end of the year. AI is a shift in the tech industry, not a new one, and can be expected to sustain the business for AMD and other chip companies, not propel them to new highs.

Analog Devices Falls On Soft Guidance

Analog Devices did not have a bad quarter or even give terrible guidance, but it was less than the market expected, and more of the same could come next quarter. The revenue of $3.26 billion is up 9.8% compared to last year and beat the Marketbeat.com consensus estimate by $0.05 billion or about 150 basis points. The automotive and industrial markets drove the strength and can be expected to underpin results moving forward. 

The top-line strength was compounded by margin improvement, which led to better-than-expected earnings. The margin improvement outpaced consensus by a wide margin and should have resulted in higher share prices, but the guidance overshadowed the strength. The company lowered its outlook to a range with the mid-point below the consensus, and there is fear that the business down-cycle could lengthen.  

The question now is, what will the analyst do? The analysts supported the stock with upgrades and price target increases that suggest 25% of upside is available now that prices are depressed. If they begin to trim their targets, the stock price could fall further. Even if the analysts come out supporting the company and stand firm with their targets, it will take some time for the market to regain confidence. The issues plaguing ADI’s outlook are tied to the broad economy and may linger for as long. 

Analog Devices Is A Cash Flow Machine 

Analog Devices is a cash flow machine producing more than $4 billion in free cash flow on a trailing 12-month basis (TTM). The company puts its cash flow to good use by investing in new technology and growth opportunities, paying dividends, and buying back shares. The company isn’t a high-yielding stock with a payout worth 1.85%, but that may get better soon. Not only are share prices moving lower, but the company is on track to increase the dividend again and isn’t far from Dividend Aristocrat status.  The yield is compounded by share repurchases nearly 3X the dividend distribution in Q2. That’s a significant tailwind for share prices but may not be enough to sustain a rally in 2023. 

Institutional support for ADI is high and growing, at least, it was ahead of the Q2 release. The institutions own about 85% of the stock and were buying on balance for the last year. Most transactions occurred in Q1 and Q2, with both quarters netting shares for the group. This activity is consistent with the current price action and may provide support at the mid-point of the long-term trading range. 

The Technical Outlook: Analog Devices Is Range Bound 

Analog Devices trended higher in the 1st half of 2023, but it is range bound longer-term and hit the ceiling this year. The post-release action confirms resistance at the top of the range and has the action near the range’s mid-point. That level may provide support, but range-bound conditions are likely to persist. If the mid-point of the range does not hold up as support, the stock could move as low as $138 before hitting the bottom. Long-term stock investors should use bounces from accepted support targets as entry points into this blue-chip tech stock.