Applied Optoelectronics, Inc. (NASDAQ:AAOI) and Xilinx, Inc. (NASDAQ:XLNX) are the two most active stocks in the Semiconductor – Integrated Circuits industry based on today’s trading volumes. The market is clearly enthusiastic about both these stocks, but which is the better investment? To answer this, we will compare the two companies based on the strength of their growth, profitability, risk, returns, valuation, analyst recommendations, and insider trends.

**Growth**

Companies that can increase earnings at a high compound rate over time are attractive to investors. Analysts expect AAOI to grow earnings at a 15.00% annual rate over the next 5 years. Comparatively, XLNX is expected to grow at a 9.16% annual rate. All else equal, AAOI’s higher growth rate would imply a greater potential for capital appreciation.

**Profitability and Returns**

A high growth rate isn’t necessarily valuable to investors. In fact, companies that overinvest in low return projects just to achieve a high growth rate can actually destroy shareholder value. Profitability and returns are a measure of the quality of a company’s business and its growth opportunities. We’ll use EBITDA margin and Return on Investment (ROI) to measure this. Applied Optoelectronics, Inc. (AAOI) has an EBITDA margin of 26.52%, compared to an EBITDA margin of 31.55% for Xilinx, Inc. (XLNX). This suggests that XLNX underlying business is more profitable. AAOI’s ROI is 12.30% while XLNX has a ROI of 15.90%. The interpretation is that XLNX’s business generates a higher return on investment than AAOI’s.

**Cash Flow **

The amount of free cash flow available to investors is ultimately what determines the value of a stock. AAOI’s free cash flow (“FCF”) per share for the trailing twelve months was +1.03. Comparatively, XLNX’s free cash flow per share was +0.35. On a percent-of-sales basis, AAOI’s free cash flow was 0.01% while XLNX converted 3.7% of its revenues into cash flow. This means that, for a given level of sales, XLNX is able to generate more free cash flow for investors.

**Liquidity and Financial Risk**

Balance sheet risk is one of the biggest factors to consider before investing. AAOI has a current ratio of 2.90 compared to 9.60 for XLNX. This means that XLNX can more easily cover its most immediate liabilities over the next twelve months. AAOI’s debt-to-equity ratio is 0.09 versus a D/E of 0.68 for XLNX. XLNX is therefore the more solvent of the two companies, and has lower financial risk.

**Valuation**

AAOI trades at a forward P/E of 9.90, a P/B of 3.54, and a P/S of 2.96, compared to a forward P/E of 25.54, a P/B of 6.99, and a P/S of 7.42 for XLNX. AAOI is the cheaper of the two stocks on an earnings, book value and sales basis. Given that earnings are what matter most to investors, analysts tend to place a greater weight on the P/E.

**Analyst Price Targets and Opinions**

Investors often compare a stock’s current price to an analyst price target to get a sense of the potential upside within the next year. AAOI is currently priced at a -33.48% to its one-year price target of $85.67. Comparatively, XLNX is 7.43% relative to its price target of $66.58. This suggests that AAOI is the better investment over the next year.

The average investment recommendation on a scale of 1 to 5 (1 being a strong buy, 3 a hold, and 5 a sell) is 2.10 for AAOI and 2.70 for XLNX, which implies that analysts are more bullish on the outlook for XLNX.

**Risk and Volatility**

To gauge the market risk of a particular stock, investors use beta. Stocks with a beta above 1 are more volatile than the market as a whole. Conversely, a beta below 1 implies below average systematic risk. AAOI has a beta of 3.04 and XLNX’s beta is 1.08. XLNX’s shares are therefore the less volatile of the two stocks.

**Insider Activity and Investor Sentiment**

Analysts often look at short interest, or the percentage of a company’s float currently being shorted by investors, to aid in their outlook for a particular stock. AAOI has a short ratio of 3.74 compared to a short interest of 11.00 for XLNX. This implies that the market is currently less bearish on the outlook for AAOI.

**Summary**

Applied Optoelectronics, Inc. (NASDAQ:AAOI) beats Xilinx, Inc. (NASDAQ:XLNX) on a total of 9 of the 14 factors compared between the two stocks. AAOI is growing fastly, has higher cash flow per share and has lower financial risk. In terms of valuation, AAOI is the cheaper of the two stocks on an earnings, book value and sales basis, AAOI is more undervalued relative to its price target. Finally, AAOI has better sentiment signals based on short interest.