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Why We’re Trimming Our Gains in Teradyne Stock

December 30. 2020. 4 mins read

In the age of Instagram influencers, authenticity has been increasing in value as an asset. Authenticity is about saying what you think and then seeing who happens to be attracted to it. In the finance world, that hasn’t traditionally been the norm. You’re always putting on dog-and-pony shows that attract new clients while convincing existing clients that they can’t live without whatever it is you’re peddling. Oftentimes, this involves cherry-picking a timeframe and showing how you managed to beat whatever benchmark makes you look best.

While trying to disguise poor performance is one problem you’ll frequently encounter in the finance industry, another is people claiming to have captured alpha that they weren’t intending to. For example, what happens when you pick a stock that does really well, but that performance has nothing to do with your original thesis? That’s where we’re sitting right now with our Teradyne (TER) position.

The Rapid Rise of Teradyne

When we say a stock has “done well,” we need to quantify that performance against a benchmark. In the case of Teradyne stock, it trades on the Nasdaq exchange, so that’s the benchmark we’ll use.

1-Year2-Year5-Year
Teradyne+69%+275%+467%
Nasdaq+43%+95%+156%

As you can see, Teradyne has trounced the Nasdaq benchmark consistently over the past five years.

We first wrote about Teradyne in a piece titled Is Teradyne Becoming an Industrial Robotics Stock? and have been holding the stock ever since at an average cost of $32.66 per share. This past summer, we trimmed 20% of our position at $88 a share. Then a few days ago, we trimmed another 12.5%. After both of these trims, our cost basis (all the money we spent buying shares in Teradyne) is nearly covered. After that, we’ll be playing with the house’s money.

Even after trimming our Teradyne position twice, it still commands an above-average weighting in our portfolio – it’s the third-largest position behind NVIDIA (NVDA) and Illumina (ILMN). With the remainder of our Teradyne position up +259% right now, we’re wondering if we should trim even more. The reason we’re inclined to continue trimming is that the company hasn’t seen much growth in industrial robotics, the business segment which led us to invest in the company, to begin with.

Teradyne and Industrial Robotics

Teradyne is one of those “skate to where the puck will be” situations. They’ve expressed a desire to pivot into industrial robotics, and acquired a number of companies to further that goal. When we look at the growth across all segments since we went long Teradyne, we see that Industrial Automation is the slowest growing division at +41% growth:

 Semiconductor TestSystem TestIndustrial AutomationWireless Test
Q1-2018373434923
Q3-20205921186969
Percent Increase+59%+174%+41%+200%

Industrial Automation as a percentage of total revenues in Q1-2018 was 10%, falling to 8% in Q3-2020. Even worse, for the first nine months of this year, Industrial Automation revenues are down -10.5% compared to last year over the same period. In other words, Industrial Automation hasn’t given us the spectacular growth we were expecting. Teradyne is actually becoming less of a pure-play in industrial robotics as time goes by.

In October 2020, Teradyne created a new position – President of Teradyne’s Industrial Automation Group – and gave the role to Gregory Smith who was previously President of Teradyne’s Semiconductor Test Division. Perhaps the company recognizes that growth in industrial robotics is not all that it could be. To make matters worse, the company isn’t benefiting from the surge of automation brought on by The Rona. Says the Q3-2020 quarterly report:

The decrease in Industrial Automation revenues of $22.0 million, or 10.5%, was primarily due to lower demand for collaborative robotic arms in the automotive and manufacturing markets amplified by the impacts of COVID-19.

While most other companies building automation solutions have benefited from The Rona, Teradyne seems to be the exception.

The 5G Thesis

We’ve talked before about how Investing in 5G Stocks isn’t as clear cut as some Fools would lead you to believe. One of our readers told us that Teradyne might have some exposure to 5G, and indeed it does. In the latest quarterly report, Teradyne says the following:

The increase in Wireless Test revenues of $20.7 million, or 18.4%, was primarily due to increased sales of 5G and WiFi 6 testers.

Credit: Teradyne Q3-2020 10-Q

The above statement refers to the below table which shows how each of Teradyne’s four primary business segments performed for the first nine months of 2020 compared to 2019:

Credit: Q3-2020 10-Q

The increase in Wireless Test revenues is attributed to 5G and WiFi 6, so we can use this segment as a proxy for their exposure to 5G and the subsequent growth we hope to see.

The above table also shows us the tremendous growth in Semiconductor Test revenues and the decline in Industrial Automation revenues discussed earlier. That’s why we’re stoked to see that the leader who drove the growth in Semiconductor Test has now been put in charge of Industrial Automation.

What We Plan to Do

Teradyne sits in our portfolio with a current weighting of 4.62%. Since we’d rather not be overweight a stock that isn’t giving us much pure-play exposure to our desired disruptive technology – industrial robotics – we’re going to continue trimming the position slowly over time until the weighting reaches 3.85%. (We have 26 stocks in our portfolio, so 1 / 26 = 3.85.) Since there are no longer any transaction costs, we can trim shares in very small amounts over a longer time frame which helps reduce market timing risk. We’re extremely skeptical of today’s irrational markets, and freeing up some cash doesn’t sound like the worst idea.

Conclusion

We always need to be honest about whether or not our gains were part of a well thought out strategy, or simply the consequences of unforeseen events. In the case of Teradyne, we’re now overweight a stock that’s not giving us the exposure we’re looking for. We’ll continue trimming the position and wait until the 2020 annual report comes out to see what the bigger picture looks like.

Teradyne is just one of 26 disruptive tech stocks we’re holding right now. Want to see the rest? Become a Nanalyze Premium annual subscriber and find out now.

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  1. I invest in Teradyne because I love its name, and even more its alphabetic lance: TER! Reminds of a prehistoric meateathing reptile doesn’t it….or more contermporaneoulsy..the first three letters of TERROR! Who needs more. Jump on board and keep their run going at least until Monday.

    The surprise of capturing the imagination of the investing public may be too much for TER’s Board and management. I have no idea who they are but in my own life there have been times when suddenly things took a supercharged turn for the positive and I was awash in uncertainty about what to do next. I don’t think this is unusual. Most become conservative in this situation.

    Want to invest in a ‘disruptive’ company with conservative management?

    1. The answer to your question is yes because we’re risk-averse investors. The logic is that because tech investing is extremely risky in the first place, a management team that manages that risk is more valuable to us as investors. We always want to take as little risk as possible with the greatest possible outcome – that whole Sharpe Ratio thing finance people talk about.

      1. Risk cuts both ways – to the investor, or course…but also to the company. When a company, over a short period of time, takes on a value which neither the investor nor the management expected there is supreme risk. Can the management handle this level of investor expectation with prudent decisions setting up revenue and FCFs commensurate with the new value? How will the investor handle a slow down or hiccup?

        The next two quarters should indicate how TER’s management views their future and their capability.

        1. True, management has a challenge in dealing with investors’ expectations. That’s why it’s much more preferred to have long-term investors on board (institutional money, strong hands) than a bunch of fly-by-night Robinhood weekday warriors.

  2. Further thoughts (since I’m still making $’s): Maybe the decision makers at TER recognize that the time is not yet right for cost saving robotics….cultivating their ‘traditional’ industrial customers, investing in R+D, and as you love to say: skating to where the puck will be! I am following you in and trimming; I hope I regret it in 2 years. I have spent time on their corporate webwite and what they offer is something special. I’m on-board with TER…but moving back from ‘First Class’ to Tourist for the time being. A very interesting company.

    1. Yes, it’s an interesting company and now the fourth largest in our portfolio as it continues to soar. We’re continuing to trim it down to a more reasonable sign and will continue to hold in hopes they get the industrial robotics division back to showing some growth. Maybe time for another acquisition?