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Bear of the Day: Cadence Design Systems (CDNS)

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Fresh volatility in the tech sector over the past two months has seen investors start to ditch previously-hot stocks with stretched valuations. One example of this trend is Cadence Design Systems (CDNS - Free Report) , which has sold off significantly after a dramatic rise to all-time highs earlier this year. If this tech volatility sticks around, it could be best to avoid these stocks right now.

Cadence Design Systems offers products and tools that help customers to design electronic products. For example, the company’s core electronic design automation software and services enable engineers to develop different types of IC design blocks to electronic systems and semiconductor customers.

CDNS has slumped more than 21% since touching a new peak in late January, but the company’s valuation still seems stretched. Meanwhile, the stock is sporting a Zacks Rank #5 (Strong Sell) and recent analyst estimates might cause further hesitation.

Latest Earnings Outlook

Cadence is expected to release its latest quarterly financial results in late April. Based on our latest Zacks Consensus Estimates, we expect the company to post adjusted earnings of 38 cents per share and total revenues of $505.8 million.

These results would actually represent respectable year-over-year improvements of 19% and 6%, respectively. However, analyst sentiment for this period—and future fiscal periods—has been less optimistic recently.

When looking at the Most Accurate Estimate, which only considers the most recent analyst estimates, we see that Cadence’s earnings projection is one penny lower for the soon-to-be-reported quarter and three cents lower for the upcoming quarter. The Most Accurate Estimate is also a penny lower for the company’s full-year and next-year earnings estimates.

Since earnings estimates and analyst sentiment have such a profound effect on a stock’s momentum, this worsening outlook is not a great sign.

Key Valuation Metrics

As mentioned, CDNS has slumped more than 21% over the past two months, but the company’s valuation is still stretched. Based on Friday’s close, Cadence was trading at 23.5x forward 12-month earnings, which is a premium compared to the broader technology sector.

The stock also has a P/S of 5.4, which means its shares are looking overvalued based on the company’s revenue picture too. Investors love to look at the P/S ratio for these smaller software and tech firms because having a strong customer base is precious in this space, so it is discouraging to see this valuation metric at this level too.

The bottom line is that investors have been quick to ditch these companies with stretched valuations in the recent tech selloff, and stocks with sluggish earnings outlooks are likely to be punished even further.

Want more market analysis from this author? Make sure to follow @Ryan_McQueeney on Twitter!

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