Silicon Motion Technology Corp. (ADR) (SIMO)

Silicon Motion Technology Corporation (SIMO) is a semiconductor company that designs, develops and markets, high-performance, low-power semiconductor solutions for the multimedia consumer electronics market. It has three product lines: mobile storage business, multimedia systems-on-a-chip (SoC) business, and mobile communications business. The company went public in 2005 and is headquartered in Taiwan; it trades as an ADR in the US.

The mobile storage business is composed of microcontrollers used in not and electronic logic gate (NAND) flash memory storage products, such as flash memory cards, universal serial bus (USB) flash drives and embedded flash. The multimedia SoC business is composed of products that support portable multimedia players, global positioning system (GPS) devices, digital audio broadcasting (DAB) systems, personal computer (PC) cameras and embedded graphics applications. And the mobile communications business is composed of mobile television (TV) integrated circuit (IC) solutions, code division multiple access (CDMA) radio frequency (RF) ICs.

I came across SIMO while looking for some inexpensive stocks for swing trades. When I plugged it into my spreadsheet, the data looked very good for a long-term value play, however, my program pulls from the Morningstar website and it only had data through 2007. The analysis presented is based on a price of $3.40 and the Morningstar data has been supplemented with information from the 2008 annual report. This is a stock that is flying under the radar; Seeking Alpha only has three articles in 2008 and three in 2007, and except for press release information, none of these articles focus on SIMO as a potential investment.

The most concerning aspect of this stock is that the EPS is that it dropped precipitously last year (from $1.20 to $0.29). Until then, the compounded annual growth (CAGR) has been 57%. Nonetheless, the free cash flow has continued to be positive as well as increase. Until 2008, return on equity (ROE) has consistently exceeded 15% (exceeding 20% in 2006). In addition, SIMO’s cash position makes up about 64% of the price of the stock and the company has no debt.

Before I look at the valuations, I look at three indicators of financial safety. For this stock, all three are quite good. The Altman Z is 4.4; below 1.8 is risky, above 3 is the safe range. The Piotroski F is 7; 2 or below indicates caution, while 8 or 9 indicates that the stock is expected to rise within the next year. The Sloan accrual is -8.23; 5 or higher is high risk, while -5 or lower is excellent.

I use more than one valuation method to gauge intrinsic value; the first three all provide a good margin of safety (MOS). The first three are standards in the valuation literature. The estimate based on Graham’s formula was $21 (84% MOS). The Earnings Power Value (value of the firm) was estimated, on a per share bases, to be $8 (57% MOS). The Discounted Cash Flow estimate valued the stock at $30 (89% MOS).

The last two were based on a spreadsheet found on the AAII website; these are designed to mimic Buffett’s valuation methodology. One is based on projecting EPS growth 10 years into the future based on past EPS growth; I discount the resulting valuation to reflect the price at which the stock will realize a compounded earnings (including dividends when applicable) return of 15%. Based on this method the target purchase needs to be below $3.62, and at the current price there is a 6% MOS.

The second is based on estimating EPS growth through the sustainable growth rate. The per-share projected book value is estimated by taking the previous year’s book value, adding EPS and subtracting dividends (when applicable). The projected EPS is estimated by multiplying the projected book value by the average Return on Equity, and the projected dividend is estimated by multiplying the projected EPS by the average payout ratio. I then discount the resulting valuation to reflect the price at which the stock will realize a compounded earnings return of 15%. Based on this method the target purchase needs to be below $7, and at the current price there is a 52% MOS.

To ascertain that the price is attractive to me, I take one more thing into consideration. At the current price, would I expect an immediate 15% return on my investment (ROI) based on earnings and dividends? In this, the EPS represents about 8.5% of the share price by itself (there is no dividend yield to add in). However, at a price of $3.40, for the stock to achieve 15% would only require an EPS of $0.51; a mark that SIMO has exceeded in every year the company has been publicly traded.

Based on value and safety, I think SIMO has excellent investment potential. The only flaw that emerged from my analysis is the immediate return on investment, and I think that is more a hurdle stemming from recent circumstance rather than a barrier that must be overcome before choosing to invest.