Featuring Lutts’ Logic:
Why Chip Stocks are Attractive Now
Six Hot Chip Stocks for the Spring Bull Market
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Today we jump right into stocks, starting with the good news that last week our intermediate-term market-timing indicator flashed a buy signal. This means all our indicators are once again unanimously positive. There’s no better time to make money than now.
But where should you invest?
I think semiconductor chips are a great sector, and there are three good reasons why.
First, business is improving. The vast majority of companies in the sector--both those that design the chips and those that manufacture them--are enjoying fast-growing sales and earnings, and expanding profit margins. Individuals and institutions are loosening their purse strings and buying again. Consumers are buying cell phones, computers, televisions and cars. Companies are buying computers, networking equipment and equipment that enables closer tracking of inventories, productivity, efficiency, etc. And the government is buying more of everything.
Second, the chip sector is notorious for its cyclicality. When times are good, companies in the industry expand, spending more money so they can keep up with demand. But demand eventually slows, leaving the companies with too much overhead. So as orders slow, they cut back (often drastically), reducing payrolls to stay profitable, some more successfully than others. Prices fall, and eventually, demand picks up again, margins boom, and companies scramble to keep up.
In short, companies in the chip industry tend to overreact when they expand, and they overreact when they cut back. And they have to, because the timing of every phase is different throughout the decades, so there’s no way of knowing how long each phase will last as it evolves. The risk is that failure to adapt could be more costly than adapting too vigorously. So the cycle goes on.
And then there’s the stock market, which is guilty of exactly the same overreaction. Seeing margins plummet in a contraction phase, as we had in 2008, investors dump chip stocks like hot potatoes. They get dirt cheap. And when the turnaround comes, these stocks climb fast, as margins boom and projections of future growth are ratcheted higher and higher. That’s the phase we’re in now. No one knows how long it will last. But I do know that it’s a great phase for making money, provided that you take care to exit when the trend ends.
Below are six chip stocks that look great today, presented in alphabetical order.
All are U.S. companies, all enjoy growing sales and earnings now, and all expect continued growth in the year ahead.
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Atheros Communications (ATHR) of Santa Clara, California, designs chips used in wireless communications and wired networks. Ethernet, GPS, Bluetooth and Powerline are its strengths. The company has grown revenues every year of the past decade and it remained profitable in every quarter of 2008 and 2009. In the latest quarter, revenues grew 89% to $186 million, while earnings jumped 265% to $0.62 per share. The after-tax profit margin was 22.2%. Technically, ATHR is strong, building a little base between 37 and 38.
Cree Inc. (CREE) of Durham, North Carolina, is a leading manufacturer of LEDs (light-emitting diodes). These are the lights that will eventually take over from incandescent and compact fluorescent lights because they are far more energy efficient, last far longer and don’t contain mercury. The company has grown revenues every year of the past decade but one (2007) and it maintained profitability throughout 2008 and 2009. In the latest quarter, revenues grew 35% to $200 million, while earnings jumped 90% to $0.38 per share. After-tax profit margin was 20.1%. Technically, CREE is very strong, consolidating its latest climb just under 70.
NetLogic Microsystems (NETL) of Mountain View, California, designs chips used to accelerate the processing and delivery of content on both wired and wireless systems. Cisco and its contract manufacturers account for 38% of revenues, while Juniper, Alcatel, Lucent and Motorola account for another 30%. The company has grown revenues every year of the past decade and it’s grown earnings every year (impressive!) since 2005. NetLogic stayed solidly profitable through 2008 and 2009, with earnings off just 24% in its weakest quarter. In the latest quarter, revenues rocketed 125% to $69.5 million, while earnings jumped 90% to $0.59 per share. After-tax profit margin was 25.1%. Technically, NETL is powerful, consolidating just above 55.
Power Integrations (POWI) of San Jose, California, is the leading manufacturer of high-voltage analog chips used in energy-efficient power conversion. It serves a wide range of end-markets, but notably fast growing is the LED market, where Cree is thriving. The company has grown revenues every year of the past decade and it’s grown earnings every year but one (2008). Power Integrations stayed profitable through 2008 and 2009. In the latest quarter, revenues climbed 56% to $66.1 million, while earnings spiked 163% to $0.42 per share. The after-tax profit margin was 18.4%. Technically, POWI is solidly positive, building a little base between 38 and 39, but trading volume is a little light, averaging 250,000 shares a day.
Skyworks Solutions (SWKS) of Woburn, Massachusetts, is the largest company of these six, with revenues on track to top $1 billion this year. It’s also the most diverse, making a variety of standard and custom chips for automotive, broadband, cellular infrastructure, energy management, medical and military markets. Skyworks had three years of revenue shrinkage in the past decade, and earnings trends are also less robust than in the companies above. In the latest quarter, revenues grew 17% to $245 million, while earnings surged 59% to $0.27 per share. The after-tax profit margin was 19.5%. Technically, SWKS is quite healthy, trading between 15 and 16. And it’s the most heavily traded of these stocks, so it’s the easiest for institutions to buy. (Even easier are the big, well-known companies--Intel (INTC), Broadcom (BRCM) and Texas Instruments (TXN)--but their stocks are so well-known and over-owned that they can’t go up like these six can.)
Last but not least is Volterra Semiconductor (VLTR) of Fremont, California, whose chips transform, regulate, deliver and monitor the power consumed by other chips. Big customers are Alcatel-Lucent, AMD, Cisco, Dell, HP, IBM, Juniper, Lenovo and Sony. The company has grown revenues every year of the past decade but earnings trends have been less reliable. In the latest quarter, revenues grew 56% to $34.2 million, while earnings mushroomed 278% to $0.34 per share. The after-tax profit margin was 24.7%. Technically, the chart is strong, with a short base at 24, but volume is light, averaging 340,000 shares per day, increases risk.
Of the six, my favorites are Atheros, Cree and NetLogic, because of a combination of fundamental and technical factors.
But I know that less experienced investors will be attracted to Skyworks and Volterra, because their stocks are lower-priced. Trouble is, those lower prices bring greater risk. Whatever you choose, be sure you manage risk appropriately, by buying on dips, and by keeping losses small.
Yours in pursuit of wisdom and wealth,
Timothy Lutts
Publisher
Cabot Wealth Advisory
Editor’s Note: From the market’s bottom in March 2003 to the low in March 2009, the S&P 500 lost 18% in total and the Nasdaq lost 3.5%. Cabot Market Letter, however, left them in the dust: Advancing a total of 94% during the past six years (nearly 12% per year). Cabot Market Letter has called every bull market since 1970. In fact, Timer Digest recently named Cabot Market Letter one of the Top Ten Timers for the last one, three, five and 10 years! Don’t miss what our indicators have to say next! Click below now for more.
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