3 Chip Makers to Benefit From the Latest Technology

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

Within the tech segment, some chip and chip-related product manufacturers and designers look well placed to benefit from the booming smartphone and tablet industry. Qualcomm (NASDAQ: QCOM), NVIDIA (NASDAQ: NVDA), and Maxim Integrated Products (NASDAQ: MXIM) are three companies that offer EPS consensus growth rates above 10% going forward, and come at reasonable valuations while also paying out bulky dividends. As the switch from older technologies to smartphones continues around the world, these firms will see plenty of growth opportunities in the upcoming years.

To be in right place at the right time 

Qualcomm develops and delivers digital wireless communication products and services based mainly on its CDMA digital technology. As an established high-end processor chip provider for mobile phones and tablet manufacturers like Samsung, Apple, Nokia, Sony, HTC, and Google, among others, the company seems poised to outperform its peers, delivering expected consensus annual growth rate of 18% for the next five years.

Trading at 18.1 times its earnings, way below the 70.4x industry average, and having yielded dividends of 1.56% over the last year (and 2.18% forward), I’d recommend buying and holding on to this stock. Its strong quarterly results portray an encouraging outlook for the upcoming years while its stock price does not yet fully reflect upside expectations.

In the short-term, earnings will most likely be driven by the rising demand of tablets and smartphones worldwide. Emerging markets, particularly China, provide plenty of growth opportunities as the switching from older technologies to smartphones is expected to continue for a few years. Its broad product portfolio positions the firm ahead of many of its competitors to benefit from the growth in demand. Furthermore, acquisitions will most likely play an important role in the future since the Atheros Communications purchase proved very fruitful by widening its product offering to include chips for consumer electronics.

By licensing its intellectual property, particularly its thousands of CDMA-related technology patents, the company has created yet another steady source of income, providing the firm with a wide moat that helps keep competitors at bay and the company sustainable in the long-term. “Essentially, phones are unable to connect to the CDMA network without paying a royalty to the company; Qualcomm's licensing arrangements with virtually every handset maker allow the firm to collect about 3% to 5% of the total price of each handset unit sold.” (Morningstar)  

The ongoing upgrade to 3G networks should boost the company´s profits in the short and mid-term. Going forward, several manufacturers have already entered agreements for Qualcomm to provide 4G technology. As the demand expands in the years to come, these products should provide new and greater sources of revenue. Meanwhile, value will be returned to investors via strong share repurchases and periodic dividend yield upsurges.

A company with many possibilities ahead 

NVIDIA used to be a PC chip manufacturer focused on graphics processors. Nowadays, it holds a wide product portfolio, operating in mobile processors, hand-held gaming, and data center segments as well. Just like Qualcomm, it targets and holds a strong position in the high-end graphics market; this obliges the company to remain innovative.

The recent development of the Tegra 4 chips is a perfect example. It has created a new set of growth prospects as several performance and efficiency upgrades make it even more attractive for handset and tablet manufacturers looking to improve their gadgets' capabilities. The iCera acquisition played a major role in this development, backing management's criteria to select takeover targets. With plenty of cash available for spending, acquisitions are not to be discarded in the future and its purchase history makes me rest at ease.

As computing becomes more visual, growth opportunities for NVIDIA are abound. Furthermore, the firm's expansion into the supercomputing field, providing scientific and industrial organizations with its Tesla product line, creates massive upside opportunities as well.

However, strong competition from Advanced Micro Devices, Qualcomm, and Intel and fast developing product cycles remain a strong concern. NVIDIA's success relies enormously on its capability to remain innovative and efficiently shift from the PC market -- that accounts for most of its current revenue -- to the mobile and tablet segment. With margins and returns considerably below the industry averages and an EPS growth rate projected in the 11%-12% range for the upcoming years, I would recommend holding on to this company.

Nevertheless, keep an eye on it, you wouldn’t want to miss an attractive investment chance. A strong performance of its Tegra chips could drive earnings upside while a pullback would make its valuation too attractive to ignore.

Another competitor  that leads the market

Maxim Integrated Products is another leading company in the tech segment. As an analog chipmaker serving various end markets, the company benefits from both mature and expanding sectors. Within this last segment, its strong relationship with Samsung positions it to massively profit from the spurt in the demand for smartphones. Moreover, its wide product portfolio opens various other development avenues, especially in the consumer electronics, industrial, and communications markets.

One of the main strengths of this company stems from its high-performance analog chips, which tend to offer long lives -- as developing them requires plenty of time, research and money -- stable pricing, and strong profitability. This provides the firm with a wide economic moat (Morningstar). Furthermore, its business model has proven very effective, returning one of the highest gross margins in the industry, usually over 60% over the last eight years.

With the ability to keep competitors behind and its products selling well, the outlook seems promising for Maxim. Going forward, its recognized engineering and design teams should provide an edge over its peers as analog systems require higher levels of customization. Its recently developed integrated power management chips that allow manufacturers to cut costs and increase battery lives should open up more opportunities.

Trading at 20.2 times P/E, at discount to the 24.8x industry average, while offering a 12% average annual consensus growth rate for the next five years to come and yielding 3.19% in the form of dividends -- accompanied by healthy cash flows and strong cash generation capabilities -- I’d recommend buying this stock.

Bottom line

As the demand for smartphones and tablets increases worldwide, the aforementioned chipmakers seem poised to benefit. Trading at reasonable prices in relation to their EPS while offering compelling long-term growth prospects, mainly due to mobile phone manufacturers, Qualcomm and Maxim are two stocks that you should add to your portfolio. 

NVIDIA was ahead of the curve launching its mobile Tegra processor, but investing gains haven't followed as expected, with the company struggling to gain momentum in the smartphone market. The Motley Fool's brand-new premium report examines NVIDIA's stumbling blocks, but also homes in on opportunities that many investors are overlooking. We'll help you sort fact from fiction to determine whether NVIDIA is a buy at today's prices. Simply click here now to unlock your copy of this comprehensive report.

Damian Illia has no position in any stocks mentioned. The Motley Fool recommends NVIDIA. The Motley Fool owns shares of Qualcomm. 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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