The past six months have been a windfall for Penguin Solutions’s shareholders. The company’s stock price has jumped 175%, hitting $51.12 per share. This was partly due to its solid quarterly results, and the performance may have investors wondering how to approach the situation.
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Why Do We Think Penguin Solutions Will Underperform?
We’re happy investors have made money, but we don’t have much confidence in Penguin Solutions. Here are three reasons you should be careful with PENG, plus one stock we’d rather own.
1. Long-Term Revenue Growth Disappoints
A company’s long-term sales performance can indicate its overall quality. Any business can experience short-term success, but top-performing ones enjoy sustained growth for years. Over the last five years, Penguin Solutions grew its sales at a mediocre 2.5% compounded annual growth rate. This fell short of our benchmarks. Semiconductors are a cyclical industry, and long-term investors should be prepared for periods of high growth followed by periods of revenue contractions.
2. Low Gross Margin Reveals Weak Structural Profitability
Gross profit margin is a key metric to track because it shows how much money a semiconductor company gets to keep after paying for its raw materials, manufacturing, and other input costs.
Penguin Solutions’s gross margin is one of the worst in the semiconductor industry, signaling it operates in a competitive market and lacks pricing power. As you can see below, it averaged a 28.3% gross margin over the last two years. Said differently, Penguin Solutions had to pay a chunky $71.68 to its suppliers for every $100 in revenue.
3. Mediocre Free Cash Flow Margin Limits Reinvestment Potential
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.
Penguin Solutions has shown poor cash profitability relative to peers over the last two years, giving the company fewer opportunities to return capital to shareholders. Its free cash flow margin averaged 3%, below what we’d expect for a semiconductor business.
Final Judgment
Penguin Solutions doesn’t pass our quality test. After the recent rally, the stock trades at 16.1× forward P/E (or $51.12 per share). This multiple tells us a lot of good news is priced in - we think there are better opportunities elsewhere. We’d suggest looking at a safe-and-steady industrials business benefiting from an upgrade cycle.
Stocks We Would Buy Instead of Penguin Solutions
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