Investors looking into the semiconductor space can find an example of almost any sort of business model they may want to buy. Some analog companies, Linear Technology (Nasdaq:LLTC) or Analog (NYSE:ADI) for instance, focus on a wide variety of proprietary high-performance analog chips. Other companies focus more on high-volume chips for consumer applications. Then there's Maxim Integrated (Nasdaq:MXIM) - a chip company that's looking to do a little bit of both.

Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.

Mixing Old with New
Maxim has a solid history in the high-performance analog space, where it garners broadly the same sort of profitable margins and long product lives as the likes of Linear and Analog Devices. More recently, though, the company has been pursuing high-volume apps like chips for handsets. Although these chips frequently have shorter cycles and lower margins, there is definitely money to be made in volume.

Maxim is adding another twist on this model, though. Increasingly the company has been focusing on more integrated solutions and looking to garner a bigger chunk of the chip content from its rivals by offering better price and performance trade-offs. While Samsung is presently the company's largest customer, the company is hoping to win more and more business from the likes of Apple (Nasdaq:AAPL) and Nokia (NYSE:NOK).

Change Comes with a Cost
The trouble with Maxim's new model is that past performance may not presage future results. By and large, Maxim's focus on high-volume chips and its greater presence in consumer ((at least relative to ON Semiconductor (Nasdaq:ONNN) or Texas Instruments (NYSE:TXN)) products suggests that past peak gross and operating margins may be very hard to regain. By the same token, perhaps the company's focus on more fully integrated systems-on-a-chip can counteract that trend.

Historically, Maxim compares reasonably well with most chip companies. There's little that any chip company can really do to counteract the basic cyclicality of the market, but the company's returns on capital and economic earnings have been pretty respectable compared to sector norms.

Will Growth Sustain Valuation?
Maxim isn't strikingly cheap today compared to highly profitable HPA companies, nor the more growth-oriented plays like Broadcom (Nasdaq:BRCM) or Mellanox (Nasdaq:MLNX). What Broadcom does offer, though, is the prospect of above-average growth combined with solid profitability. This move into higher-volume consumer products and more integrated products could make it a share-gainer in the chip sector, giving it a chance at above-average revenue growth.

That's often a major step forward in garnering a robust valuation from growth-obsessed tech investors. The bigger question, though, may be whether Maxim can couple that with the expected levels of productivity, as sell-side numbers do assume a fair bit of improvement.

The Bottom Line
I can understand the appeal of the Maxim Integrated story; above-average growth and share gains, bulwarked by a very profitable legacy HPA business. That said, I wouldn't pay just any price to get that combination.

Today's valuation just doesn't look all that appealing to me. Forward-looking free cash yield (projected free cash flow divided by enterprise value) looks to be sub-5% right now; not enough to really entice me given the highly competitive nature of this market. What's more, a multi-year discounted free cash flow model suggests a fair value of around $29 for these shares - quite close indeed to the current price. For related reading, see Valuing Firms Using Present Value Of Free Cash Flows.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Investing News

    Bank Stocks: Time to Buy or Avoid? (WFC, JPM, C)

    Bank stocks have been pounded. Is this the right time to buy or should they be avoided?
  2. Stock Analysis

    Why the Bullish Are Turning Bearish

    Banks are reducing their targets for the S&P 500 for 2016. Here's why.
  3. Stock Analysis

    How to Find Quality Stocks Amid the Wreckage

    Finding companies with good earnings and hitting on all cylinders in this environment, although possible, is not easy.
  4. Investing News

    What You Can Learn from Carl Icahn's Mistakes

    Carl Icahn has been a stellar performer in the investment world for decades, but following his lead these days could be dangerous.
  5. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  6. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  7. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  8. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  9. Investing News

    Chipotle Served with Criminal Probe

    Chipotle's beat muted expectations and got a clear bill from the CDC, but it now appears that an investigation into its E.coli breakout has expanded.
  10. Stock Analysis

    Analyzing Sprint Corp's Return on Equity (ROE) (S)

    Learn about Sprint's return on equity. Find out why its ROE is negative and how asset turnover and financial leverage impact ROE relative to Sprint's peers.
RELATED FAQS
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center