"However, due to stronger demand than I had anticipated from several other sectors, ADI reported stronger FQ3 results than I would have expected.

"This is good news on two fronts. First, the inventory adjustment for the Chinese wireless business is behind us and was offset by better than expected demand from other sectors and, second, we should see wireless demand improve in FQ4.

"Between this and other commentary ADI shared during its conference call, I think we can take its guidance for both revenue and earnings as being somewhere between conservative and very conservative.

"Initially, Wall Street has clearly focused on the wrong thing: a slightly lower than expected gross profit margin for FQ4. In the scope of things, this focus made less sense than a bookie handicapping an Olympic runner due to a hangnail.

"Among the many things Wall Street was failing to grasp here is that ADI is designed to operate efficiently at roughly $600M in revenue. Because it is operating at a lower level than that today, it is not fully absorbing its fixed costs.

"Between this and the fact that certain sectors that generate higher relative gross margins have been slower to recover than sectors with lower relative margins, aggregate gross profit margins are currently constrained.

"Worse yet than focusing on near term results and using year-over-year comparisons to judge ADI, there was apparently no attention given to where ADI has been and where it is headed.

"ADI was very early in realizing it needed to change its business model. What happened was ADI developed strong presence in both the handset DSP and PC power control markets only to see margins decline over time as the technology became easier to produce.

"However, to its credit, ADI sold its handset business and ADI has benefited by refocusing on high margin opportunities.

"It's not that this model isn't working, it's just that its progress is masked by the combination of an unusual product mix attributable to the aggregate demand environment and the burden of inefficiently absorbed fixed costs.

"As we move forward, there are three primary things that I believe will materially boost not only ADI's gross profit margins, but its operating profit margin and bottom line earnings as well:

1. Improved economy of scale - as revenues go up, fixed costs are more efficiently absorbed
2. Lower capital spending will lead to lower depreciation charges
3. Improved mix of products that more strongly favors higher relative margin product categories

"One of my keen focuses is to quantify how well a business model leverages investment in R&D and SG&A. Think about it this way: these are the two factors representing the company's investment in profit and growth.

"Therefore, we need to measure how well the company invests here and executes. As a matter of fact, this might be the single most important thing a company does.

"An easy way to measure this is to simply divide non-GAAP gross profit dollars by non-GAAP R&D plus non-GAAP SG&A.

"Doing this tells you how many gross profit dollars a company generates for every dollar invested in operating costs. This represents how well a company does everything from picking the right product or service to sell to how well they design, build, market, sell and administrate.

"This is what I call an 'Operational Elegance' (OE) ratio and it represents how well a company does everything from picking the right product or service to sell to how well they design, build, market, sell and administrate.

"In the conference call, CEO Jerald Fishman tried to communicate that ADI is clearly focused on leveraging the return on its operational expense investments - he gets it.

"I talk with many senior executives and you would be absolutely amazed how few really embrace this operational concept; many actually think you can't focus both on leverage and growth optimization - bunk; you can if you really know how to run a company.

"Analog Devices last reported an OE ratio above 2.0 to 1 during the 2000 bubble. My bet is that ADI will return to that ratio, but this time leveraging a model that I think will sustain it for the long-term rather than just as a 'hurrah' when riding a bubble.

"My second bet is that ADI will hit that ratio inside two years and by the time it does, the stock will be trading for over $40.

"The short story here is I think ADI will grow revenue faster than its peers, mostly by successfully expanding its served market, and grow profits notably faster than revenue during the coming 12 to 24 months."

Steven Halpern's TheStockAdvisors.com offers a free daily overview of the favorite stock picks and investment ideas from the nation's leading financial newsletter advisors.