Over the past six months, Cadence Design Systems’s shares (currently trading at $290.70) have posted a disappointing 15.8% loss, well below the S&P 500’s 6.2% gain. This may have investors wondering how to approach the situation.

Following the drawdown, is now a good time to buy CDNS? Find out in our full research report, it’s free.

Why Does CDNS Stock Spark Debate?

Powering the chips behind everything from smartphones to AI accelerators for over 35 years, Cadence Design Systems (NASDAQ: CDNS) provides essential computational software, hardware, and intellectual property used by engineers to design and verify advanced electronic systems and semiconductors.

Two Positive Attributes:

1. Elite Gross Margin Powers Best-In-Class Business Model

Software is eating the world. It’s one of our favorite business models because once you develop the product, it usually doesn’t cost much to provide it as an ongoing service. These minimal costs can include servers, licenses, and certain personnel.

Cadence Design Systems’s gross margin is one of the highest in the software sector, an output of its asset-lite business model and strong pricing power. It also enables the company to fund large investments in new products and sales during periods of rapid growth to achieve higher profits in the future. As you can see below, it averaged an elite 87.4% gross margin over the last year. Said differently, roughly $87.44 was left to spend on selling, marketing, and R&D for every $100 in revenue.

The market not only cares about gross margin levels but also how they change over time because expansion creates firepower for profitability and free cash generation. Cadence Design Systems has seen gross margins decline by 1.9 percentage points over the last 2 year, which is poor compared to software peers.

2. Customer Acquisition Costs Are Recovered in Record Time

The customer acquisition cost (CAC) payback period represents the months required to recover the cost of acquiring a new customer. Essentially, it’s the break-even point for sales and marketing investments. A shorter CAC payback period is ideal, as it implies better returns on investment and business scalability.

Cadence Design Systems is extremely efficient at acquiring new customers, and its CAC payback period checked in at 8.1 months this quarter. The company’s rapid recovery of its customer acquisition costs means it can attempt to spur growth by increasing its sales and marketing investments.

One Reason to be Careful:

Weak Billings Point to Soft Demand

Billings is a non-GAAP metric that is often called “cash revenue” because it shows how much money the company has collected from customers in a certain period. This is different from revenue, which must be recognized in pieces over the length of a contract.

Cadence Design Systems’s billings came in at $1.47 billion in Q4, and over the last four quarters, its year-on-year growth averaged 14.8%. This performance slightly lagged the sector and suggests that increasing competition is causing challenges in acquiring/retaining customers.

Final Judgment

Cadence Design Systems’s positive characteristics outweigh the negatives. After the recent drawdown, the stock trades at 12.7× forward price-to-sales (or $290.70 per share). Is now a good time to initiate a position? See for yourself in our full research report, it’s free.

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