Shareholders of FormFactor would probably like to forget the past six months even happened. The stock dropped 22.6% and now trades at $34.21. This may have investors wondering how to approach the situation.
Is there a buying opportunity in FormFactor, or does it present a risk to your portfolio? See what our analysts have to say in our full research report, it’s free.
Why Do We Think FormFactor Will Underperform?
Even though the stock has become cheaper, we're cautious about FormFactor. Here are three reasons why there are better opportunities than FORM and a stock we'd rather own.
1. Long-Term Revenue Growth Disappoints
A company’s long-term sales performance is one signal of its overall quality. Even a bad business can shine for one or two quarters, but a top-tier one grows for years. Regrettably, FormFactor’s sales grew at a sluggish 4.4% compounded annual growth rate over the last five years. This fell short of our benchmark for the semiconductor sector. Semiconductors are a cyclical industry, and long-term investors should be prepared for periods of high growth followed by periods of revenue contractions.
2. Projected Revenue Growth Is Slim
Forecasted revenues by Wall Street analysts signal a company’s potential. Predictions may not always be accurate, but accelerating growth typically boosts valuation multiples and stock prices while slowing growth does the opposite.
Over the next 12 months, sell-side analysts expect FormFactor’s revenue to rise by 2.4%, close to its 4.4% annualized growth for the past five years. This projection is underwhelming and implies its newer products and services will not lead to better top-line performance yet.
3. Free Cash Flow Margin Dropping
If you’ve followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can’t use accounting profits to pay the bills.
As you can see below, FormFactor’s margin dropped by 6.4 percentage points over the last five years. It may have ticked higher more recently, but shareholders are likely hoping for its margin to at least revert to its historical level. Almost any movement in the wrong direction is undesirable because of its relatively low cash conversion. If the longer-term trend returns, it could signal it’s in the middle of a big investment cycle. FormFactor’s free cash flow margin for the trailing 12 months was 8.4%.
Final Judgment
We see the value of companies furthering technological innovation, but in the case of FormFactor, we’re out. Following the recent decline, the stock trades at 23.3× forward P/E (or $34.21 per share). This valuation tells us it’s a bit of a market darling with a lot of good news priced in - we think there are better opportunities elsewhere. We’d suggest looking at one of our all-time favorite software stocks.
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