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When The Chips Are Down
By Steve Lord
Dear American Capitalist Readers,
I have been keeping tabs on the semiconductor sector recently, watching many of these firms either trend flat or head south for the last several months. While investors have been glued to the price of oil and the decline in housing, tech stocks have very quietly made a variety of technical bottoms. In the meantime, many classic technology names are trading at discounts to their historical forward price/earnings ratios.
That may change later this spring. The semis are a very cyclical group and they discount economic activity very early. In other words, their prices began to reflect a slowing economy and weaker consumer spending last summer. As a result, most smaller-cap semi stocks have had a tough go of it lately; The Philadelphia Semiconductor Index, or SOXX, fell over 20% last spring as emerging markets corrected and has since clawed its way back only roughly half the distance.
With the sector off the radar of most investors and valuations in the sector compelling, there is a strong likelihood of a rebound in the group before summer. And when one looks through the program from last week’s Consumer Electronics Show, it’s apparent technology continues to be ever more pervasive in our lives. There is even a company selling glasses with tiny video screens embedded in them now, and video content over the internet is the new “next big thing.” Chip demand is alive and well.
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There are a number of ways to play a rebounding tech and semiconductor industry, and although not all the pieces have fallen into place yet (I’d still like to see inventory levels come down a little bit), it might make sense to start poking around in the sector. I like APPLIED MATERIALS for a general, all-comers type of stock that will move in tandem with the entire industry’s fortunes. Coming off a bottom at $16 in the summer, the stock has moved to nearly $20 in a picture-perfect technical bounce. Meanwhile, it is exposed to all facets of the chip industry as the largest semiconductor equipment maker in the world, so a meaningful reduction in chip inventory should result in strong revenue growth. Trading for a forward P/E of 15 compared to its historical average over 20, the company’s valuation is attractive, while it also boasts little debt, return on equity over 20%, $1.9 billion in cash flow annually and a PEG ratio just over 1.
By the time you are reading about improving business in the semiconductor sector, AMAT could be over $25 and the opportunity will have been missed. Conversely, if inventories don’t drop and consumer spending proves to be weaker than expected this quarter and next, the stock will likely retrace its recent steps and head back down to $16. But from here, downside risk is minimal while upside potential is significant. AMAT is worth a look.
Sincerely,
Steven Lord, Editor, GRESSOR