This Stock Has the Golden Touch

Many investors focus on short-term trends, buying or selling stocks in anticipation of how the current quarter will play out. This myopic approach can keep them from finding great long-term investments.

Touch-screen maker Synaptics (Nasdaq: SYNA) is a prime example. The company recently reported a tepid fiscal 2010 second quarter and provided cautious near-term guidance, sending shares down more than -10%. Investors should have paid closer attention to the longer-term path, which appears increasingly bright.

In recent years, a host of new computing and handheld devices have arrived that enable users to give commands by touching the screen. Many of those devices incorporate Synaptics’ technology, helping to boost sales from $267 million in fiscal 2007 to $473 million in fiscal 2009. But the global slowdown, coupled with increasing competition, is likely to lead to a sharp slowdown in growth in the current fiscal year, perhaps in the -5% to -7% range. Looking out to fiscal 2011 beginning this summer however, sales growth should glide back up, as the company’s recent design wins translate into new products arriving on the market.

At the recent Consumer Electronics Show (CES), Synaptics showed off a pair of new technologies that take touch screens to the next level. The first, called “Scrybe,” allows users to customize their devices to tailor certain finger movements to specific commands. Users can launch applications without ever leaving the screen they are working on. For example, selecting a word or phrase by double-tapping and then tracing the “?” symbol can automatically launch the browser and perform an immediate directed search for the selected word or phrase. The company’s “Fuse” concept utilizes a host of other features that cell phone makers are expected to incorporate in upcoming models, including the ability to use several fingers at once to expand or shrink an application, greater feedback to let the user know if a certain command cannot be completed, and 3-D graphics. These technologies are not expected to impact sales until the new fiscal year starts this summer.

Of course, the rapid adoption of touch screen technology has brought a raft of new companies into this sphere, which has led some to expect market share erosion and shrinking profit margins. More than likely, Synaptics will indeed lose share, but will merely have a smaller slice of a larger pie. Synaptics also has a considerable set of patents, so new entrants are unlikely to be as cutting -edge, instead competing for the low end of the market.

Why should the total pie grow larger? As an example, the recent introduction of Microsoft’s (Nasdaq: MSFT) Windows 7 is expected to sharply boost the number of PC-based laptops and netbooks that come packaged with touch-screen technology. In addition, Synaptics’ technology is used on Google’s (Nasdaq: GOOG) new Nexus One smartphone. Barnes & Noble’s (NYSE: BKS) Nook e-reader also uses Synaptics’ touch screen technology. As demand for these products builds, revenue growth rates should rebound back to robust levels. That’s not likely to happen in the current quarter, but management noted that demand should perk back up in the June quarter , which is the first quarter of the next fiscal year, setting the stage for more robust annual growth in fiscal 2011 .

As growth resumes, Synaptics’ reasonable valuation should come into sharper focus. The company is likely to earn about $2 a share in the current fiscal year, though per share profits should rise +20% to +25% in fiscal 2011. After last week’s selloff, shares trade for about 12 times projected fiscal 2011 earnings — a nice entry point for a company with cutting-edge technology in a field expected to keep growing at a fast clip. Synaptics has been backing up that bullish outlook by repurchasing about 5% of the share count in the past few quarters.

As the current quarter progresses, investors should look past the recent tepid results and anticipate more robust sales activity in subsequent quarters. Synaptics is unlikely to remain out of favor for too long.

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