Over the last six months, Allegro MicroSystems’s shares have sunk to $35.80, producing a disappointing 6.1% loss - a stark contrast to the S&P 500’s 10.5% gain. This might have investors contemplating their next move.
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Why Is Allegro MicroSystems Not Exciting?
Despite the more favorable entry price, we’re cautious about Allegro MicroSystems. Here are three reasons why ALGM doesn’t excite us, plus one stock we’d rather own.
1. Revenue Growth Flatlining
Long-term growth is the most important, but short-term results matter for semiconductors because the rapid pace of technological innovation (Moore’s Law) could make yesterday’s hit product obsolete today. Allegro MicroSystems’s recent performance shows its demand has slowed as its revenue was flat over the last two years. 
2. Weak Operating Margin Could Cause Trouble
Operating margin is one of the best measures of profitability because it tells us how much money a company takes home after procuring and manufacturing its products, marketing and selling those products, and most importantly, keeping them relevant through research and development.
Allegro MicroSystems was profitable over the last two years but held back by its large cost base. Its average operating margin of 2% was weak for a semiconductor business. This result isn’t too surprising given its low gross margin as a starting point.
3. Mediocre Free Cash Flow Margin Limits Reinvestment Potential
Free cash flow isn’t a prominently featured metric in company financials and earnings releases, but we think it’s telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
Allegro MicroSystems 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 8.1%, below what we’d expect for a semiconductor business.
Final Judgment
Allegro MicroSystems isn’t a terrible business, but it doesn’t pass our bar. After the recent drawdown, the stock trades at 33× forward P/E (or $35.80 per share). This valuation tells us a lot of optimism is priced in - we think there are better stocks to buy right now. We’d recommend looking at one of our top software and edge computing picks.
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