Logitech International (NASDAQ:LOGI), the Swiss/U.S. hardware and software technology company, has been experiencing accelerating growth rates. Great, right? But the problem for investors is that Logitech stock already reflects this high growth rate in its valuation. There might not be much left on the upside, at least for the near term.
For example, Logitech stock has already risen 56% so far this year. And that is after it dipped 22% in the first quarter, when the Covid-19 pandemic hit almost every stock.
But this issue is the stock trades for 33 times forward earnings for its fiscal year ending March 2021. That high price-earnings ratio assumes growth will continue at its breakneck speed for a long time.
Logitech’s Impressive Growth
The company reported impressive earnings growth for the quarter ending June 30. Sales were up 23% year-over-year, and up 25% on a constant currency basis. Moreover, its non-GAAP earnings per share (EPS) were up 64% year-over-year.
Moreover, its free cash flow (FCF) shot up almost 400% from $27.2 million last year to $106.5 million. That is an incredibly fast growth rate for FCF.
Moreover, FCF represented 13.5% of its $791.9 million in quarterly sales. That also represents a very impressive FCF margin. It means that for every $100 in sales, $13.50 is converted into free and clear cash, after all expenses and capex spending.
Covid-19 Is Powering Growth
Logitech essentially sells peripherals for PCs, gaming, music, tablets and mobile devices. As people have been stuck at home, working and playing on their computers and other devices, its sales have taken off.
For example, the company offers a special keyboard specifically for gaming enthusiasts, including special features for that application. Keyboards account for 18.3% of its sales, as of Q1.
Keyboards are its second-highest product sales category, after gaming devices. Gaming accounts for 22.9% of sales. These categories can be seen in its slide presentation to investors on July 20. Gaming device sales grew an impressive amount, up 38%, on a year-over-year.
But its third-largest category, video collaboration products, grew the fastest, up over 83% year-over-year. Demand for video has increased from three sources: home, work, and gaming applications. In effect, everyone is now using video. This is a direct result of Covid-19 related restrictions and lockdowns.
And that brings up a clear issue. When Covid-19 restrictions ease, especially with the introduction and availability of a vaccine, these growth rates may fall.
Risks to the Downside
So I have effectively brought up the two main risks to this stock. These are valuation relation risks and growth-related risks.
For example, analysts polled by Yahoo! Finance expect earnings this year to March 2021 to hit $2.25, but just $2.55 next year. This years’ earnings will be higher by just 4.65%. Next year’s earnings will be up 13.3%.
Those growth numbers don’t justify a 33 times forward P/E ratio. Of course, the growth in EPS could be too low. But even the estimated growth rates for FY 2022, for 13.3% seem way too low for the high valuation, even if Covid-19 home restriction peripheral device buying slows.
What Analysts Are Saying About Logitech Stock
After the company posted its recent earnings figures, both Wedbush and JPMorgan downgraded their stock recommendation on Logitech to neutral. Both companies had previously rated the stock as either outperform or overweight. Obviously the more than doubling of Logitech stock since its bottom in mid-March accounts for their pullback recommendations.
Recently in May 2020, the company authorized a $250 million share repurchase program. This was detailed in the company’s recent annual 10-K filing, on page 34.
However, as of the end of June 30, it had not bought back any shares. And there is no wonder to this. The company itself must also feel that the stock has moved up past a reasonable valuation. Otherwise, it would have followed through on the share buybacks.
Moreover, it is not even clear if Logitech is going to continue to pay its dividend. All that the company has said is that it pays the dividend once a year. It needs specific shareholder approval to pay a dividend. This usually happens in September.
So every year, shareholders wait to see if any dividend is proposed to be approved at the annual meeting. Whether that happens this year, given that buybacks are not yet done, is up in the air.
What To Do With Logitech Stock
I suspect that most investors will wait to see if the stock gets a bit cheaper before they buy into Logitech stock. Or they may wait to see if the stock treads water while its earnings grow. That would also lower the effective P/E ratio.
For example, according to Morningstar, the average 5-year P/E ratio for Logitech stock has been 27.3. That is 18% below the forward P/E ratio for the stock today. That implies that most investors will wait for the stock to get at least 20% to 25% cheaper before they buy.
Moreover, if Logitech stock keeps moving higher the growth rate would have to increase for the stock to be cheaper on a P/E ratio basis. Therefore, most patient value investors will wait for a more opportune time to buy Logitech stock.