The Key to Success for These 3 Semiconductor Stocks

Masam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Writing on semiconductor companies is a tough job given the many complicated terms encountered that have to be described to general investors looking for high-yielding stocks. The following article briefly discusses the three best stocks in the semiconductor industry.

Linear Technology Corp. (NASDAQ: LLTC)

Linear Technology is considered to be a top pick for 2013. The stock is viewed as a core holding exhibiting both defensive (strong cash flow, dividend and returns profile) and offensive (better forward top-line growth as iPads and handsets no longer set hard comparisons) characteristics. The bullish stance on the stock is based on:

(1) An improving product mix away from computing/handset to automotive (increasing content)/industrial (energy-efficiency);

(2) The transition from a net debt position (-$1.07 billion or -$4.03/share in C2Q07) to a net cash position ($509.2 million or $2.16/share exiting C3Q12); 

(3) Strong cash flow generation (106 quarters of positive cash flow with a FCF yield of 6.5% vs. Analog peers’ at 5.4%).

It will not be wrong to say that Linear Tech is the most structurally sound company in the semiconductor industry; weakness is almost certainly macro-related and NOT company-specific.

Micron Technology (NASDAQ: MU)

The bullish stance on Micron is based on the company’s continued execution of its strategy to diversify its revenue stream from primarily DRAM (Dynamic Random Access Memory) to NAND (a storage technology that doesn’t require power to retain data) and NOR and gross margin expansion opportunities driven by a better mix of Server DRAM vs. PC DRAM. Micron’s structurally improving business model will enable stronger cash flow generation relative to prior cycles and support a stock that trades above book value.

Additionally, it is interesting to note that on the DRAM side, the company is favorably exposed to more profitable server DRAM and is gaining traction in Mobile. On the NAND side, the company is favorably exposed to corporate/client SSDs (Solid State Drive that offers remarkable data speeds and low power consumption). Relative to NOR, Micron’s acquisition of Numonyx gives it a scale advantage from being one of two memory manufacturers that makes all three memory products.

Analog Devices (NASDAQ: ADI)

Given the structural concerns surrounding consumer tech and the expectations for a significant deceleration in the handset market going forward, the “Not Consumer” seems to be an investible theme for 2013. With 80% of its revenue levered to the Industrial, Auto and Infrastructure markets (IAI), Analog Devices is poised to see better relative growth than peers in 2013 – it is important to note that on average, a company in this space has 39% of revenue exposed to IAI.

In addition to better growth, the Street expects better relative ROI as many digital/consumer semiconductor companies struggle with the increasing costs and complexity of moving down Moore’s law. (Moore’s Law, the observation that the number of transistors on an integrated circuit doubles every two years, has been the cornerstone of tech economics for over 40 years). Better growth and ROI should support relative multiple expansion.

Foolish Bottom Line

A common theme in all the above-mentioned stocks is that their key to success is sizable exposure to the right markets and low exposure to the declining markets.

AnalystX has no position in any stocks mentioned. The Motley Fool recommends Linear Technology. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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