Why Cadence Design Systems Rallied 17.1% in April

Shares of semiconductor software design firm Cadence Design Systems (NASDAQ: CDNS) rallied 17.1%, according to data from S&P Global Market Intelligence.

Cadence makes the electronic design automation software that chipmakers use to design chips. In addition, Cadence also has two other smaller but very high-growth segments in chip IP blocks, which chip designers can easily incorporate into their own designs, as well as overall system design and analysis software.

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While there was a lot of concern for tech stocks and specifically semiconductor stocks following April 2 "Liberation Day," Cadence reported strong Q1 earnings toward the end of the month and raised its full-year guidance. Moreover, management said it wasn't seeing any tariff-related change in customer behavior three weeks after April 2.

AI chip competition is overwhelming macro concerns

In the first quarter, Cadence reported revenue growth of 23.1% to $1.24 billion, meeting expectations, and adjusted non-GAAP (adjusted) earnings per share grew 34.2% to $1.57, coming in ahead of expectations. However, perhaps more important was that Cadence actually increased its revenue guidance for the full year to 12% growth at the midpoint, and $6.78 in adjusted EPS at the midpoint.

Coming off of April 2, many had feared the worst, especially for chip companies. However, CEO Anirudh Devgan noted Cadence hadn't noticed any change in its customers' behavior, saying:

We haven't seen any shifts in customers' behavior at this time, as they continue investing in their next generation designs, recognizing that today's R&D efforts are critical to deliver their groundbreaking products of tomorrow. Additionally, our ratable software business model, strong Q1 exit backlog and a predominantly recurring revenue mix, provide resilience and excellent visibility.

More and more companies are designing their own proprietary chips for various use cases to drive differentiation, whether it's the cloud providers or even new AI start-ups designing their own AI accelerators, or existing chip giants such as smartphone chipmaker Qualcomm trying to penetrate new verticals such as autos and PCs in order to diversify, for instance.

Even though Cadence's customers operate in a cyclical industry, given that custom chipmaking is usually a major strategic goal and it can take years for new designs to come to fruition, the research and development behind custom chipmaking going to Cadence is unlikely to get cut, even in a bad economy.

Cadence is a great company, but at a high price

Given its lower-risk, double-digit growth outlook, it's no wonder Cadence now trades at over 45 times this year's adjusted earnings estimates. That's certainly not cheap, but it is perhaps a fitting valuation for a company that has delivered low to mid-teens growth and margin expansion every year for the past six years.

In the age of AI, investors should probably expect great growth and margins for Cadence, and it should perform well over the long term. That being said, it may be hard for the stock to garner significant upside in the near-term, given its fairly full valuation.

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Billy Duberstein and/or his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Cadence Design Systems and Qualcomm. The Motley Fool has a disclosure policy.