By Nicholas Rossolillo, The Motley Fool, Trades Of The Day, 2024-06-18
Nvidia rightfully commands the spotlight when it comes to generative artificial intelligence (AI) right now. But behind these powerful Nvidia chips spawning new software features, business automation, and accelerated computation, there's a suite of design software tools used by the engineers to make it all possible: electronic design automation (EDA).
Synopsys (SNPS) is the leader in EDA software, boasting a large portfolio of intellectual property and patents — absolutely foundational stuff to the semiconductor industry and to AI development. Here's why the stock is, at the very least, worthy of your attention.
A bet on chip and AI research and development growth
Synopsys is a powerful platform business.
Like a select few other EDA businesses (including Cadence Design Systems, the second-largest player), Synopsys combines various software tools and specialized hardware for engineers to design and verify chip and computing systems.
Be it Nvidia, a data center customer, or one of the many other semiconductor and computing businesses, it's highly likely Synopsys' tools are being used in engineering teams' design work.
Given its broad suite of software and patent portfolio on critical parts and pieces to a modern computing system, Synopsys has become a type of bet on overall semiconductor and AI research and development (R&D) growth.
Semiconductor and data center businesses tend to hold their R&D expense growth fairly stable, regardless of the normal sales cycle inherent with hardware. The reason? If a company lets its foot off the gas in R&D, it could fall behind its peers technologically, which can have a negative impact on future sales and profitability.
As a result, Synopsys has been reporting consistent revenue growth for years. So far in its current fiscal year, revenue is up nearly 19% from the year prior. Net income and free cash flow can be lumpy (owing to the timing of some of its customer projects), but by and large, this is a highly profitable software platform, too.
Synopsys as a secret AI stock
Many investors may have become aware of Synopsys in 2024 due to two events.
First, Nvidia announced (originally in 2023) that Synopsys and leading chip fab Taiwan Semiconductor Manufacturing would integrate Nvidia's AI-fueled cuLitho generative AI algorithm to help accelerate chip development and manufacturing. Score one for Nvidia.
And second, Synopsys announced a mega-acquisition back in January, of system design and physics simulation software giant Ansys. The deal is still pending regulatory review, but the proposed tie-up underscores how chip and AI designs are becoming increasingly pervasive in all parts of the economy.
Be it data centers or more “traditional economy” systems like industrial equipment, manufacturing facilities, or cars, electronic designs are beginning to merge with mechanical ones. Synopsys acquiring Ansys would help it further its lead in EDA software as a result (and has set off a round of other acquisitions in the industry as well).
Is Synopsys stock a buy?
Given its steady and profitable growth, all deeply tied into the burgeoning AI industry, Synopsys could be a top investment in the years ahead. It does come with a steep price tag, though — 64 times trailing-12-month earnings per share (EPS), or 45 times EPS based on Wall Street analysts' current year expectations.
This is near the high end of where the stock has traded over the long term, as more investors catch on to the key role Synopsys plays in the AI race. The high price tag may also reflect some optimism surrounding the potential Ansys takeover, should that occur early in 2025.
To help with the premium price, investors interested in Synopsys might consider using a dollar-cost average plan to build a position over time. Automating purchases, perhaps on a monthly basis, could lock in some buys when there's a dip in share price.
At any rate, given Synopsys' position in the AI revolution, this is a business worth keeping tabs on, as it is behind the scenes helping companies like Nvidia make rapid advances in computing technology.
— Nicholas Rossolillo
Source: The Motley Fool
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