Why Cadence Design Systems Plunged Late in the Day Today

Shares of electronic design automation company Cadence Design Systems (NASDAQ: CDNS) dropped late Wednesday, finishing the day down 10.4%.

Cadence is just one of a handful of companies that makes the software semiconductor designers use to design chips. With the increasing variety of chips and number of chipmakers proliferating over the past decade, it has been an excellent business.

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However, a Financial Times article published late Wednesday said that the Trump administration may cut off these companies' Chinese revenues.

Will the Trump administration cut off China?

Late on Wednesday, the Financial Times said the Trump administration's Commerce Department has instructed Cadence, along with its oligopoly competitors Synopsis and Siemens EDA, to stop selling their software to China.

Image source: Getty Images.

The past couple of presidential administrations have been grappling with how to slow China's advances in artificial intelligence (AI) technology, without hurting U.S.-based chipmakers that also sell into China's massive market. Past administrations have already cut off the most advanced semiconductor manufacturing equipment to China, but if the FT article is correct, it appears the Trump administration may be attempting to cut the leading chip design software technologies off as well.

In its most recent annual report, Cadence stated that China made up about 12% of its revenue, down from 17% in the prior year. So, it's perhaps no wonder Cadence's stock is down by roughly the same percentage today.

Shareholders should sit tight

It's hard to draw conclusions from this late-day FT piece, but it appears that the market may already be pricing in a worst-case scenario already, given the sudden double-digit decline.

That said, Cadence was an expensive stock to begin with, as shares were trading at 82 times trailing and 47 times forward earnings coming into the day.

As is the case with most leading chipmakers and semiconductor-oriented names, these are generally high-quality businesses with strong growth outlooks on the back of the AI boom; however, that means they are also vulnerable to geopolitics. It makes for a volatile brew.

That being said, Foolish investors shouldn't shy away from chip stocks, as semis have been the best-performing sector over the past decade.

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Billy Duberstein has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Cadence Design Systems and Synopsys. The Motley Fool has a disclosure policy.