Linear Technology Typifies "Typical" Semiconductor Stock

A positive earnings surprise from semiconductor manufacturer Linear Technology Corp. (NASDAQ: LLTC) in mid January is credited for sparking the recent run-up in the value of semiconductor stocks as a sector. After its latest earnings release, Linear Technology shares gapped higher at the open and the shares were up 11 percent after a couple hours of trading. Other, related semiconductor stocks followed with gains of their own. Reflecting the gains, the PHLX Semiconductor Index – SOX – was up over 10 percent for the month of January with one day of trading remaining. However, when the valuation of Linear Technology is analyzed over a longer period, the analysis shows how difficult it is for a company in this sector to stand out from the crowd.

Linear Technology designs, manufactures and markets analog integrated circuits. The products are used in a wide range of manufactured products ranging from cell phones to cars. Its a good business. For the company's 2012 fiscal year second quarter, released on January 18, net profits of $88 million were earned on revenue of $294 million.

In that second quarter earnings release Linear Technology reported revenues 23 percent below the same quarter a year earlier and profits down by 39 percent. Results were also below those of the FY 2012 first quarter. The positive news which sparked the share price rally was the company's forecast that revenues would rise by 4 to 8 percent in the following quarter – the Linear Technology 2012 third quarter. This forecast was viewed as news that sales for the entire sector are due for an upswing.

The interesting part of the analysis comes when the share price of Linear Technology is compared to the value changes of SOX – the semiconductor index over a longer period of time. An overlay of the two charts – with a one year time frame – shows the value of Linear and SOX were very closely tied together. The comparison is actually surprising how closely Linear tracked the SOX. After the year, the Linear Technology return was 6 percent and SOX was up 5.2 percent. Laying competitors which produce analog semiconductors like Analog Devices (NASDAQ: ADI) and Maxim Integrated Products (NASDAQ: MXIM) along the SOX chart produces similar results. Analog Devices should see significant growth from sales of microelectromechanical devices (MEMs) and sensors to the energy and healthcare fields.  Given significant levels of R&D in both fields and a move towards measuring and producing on the micro level, the company should be in good shape to produce robust earnings growth.  Maxim's investment in R&D have paid off, too.  A speciality semiconductor manufacturer like Linear, Maxim is likely to maintain strong growth due to demand from HD devices, touchscreens and other products that need LCD logic, control and LED technology.  Both Maxim and Linear can successfully co-exist in this market.  These simple comparisons show that it is difficult for a semiconductor company to break away from the highly cyclical nature of the semiconductor sector, however.

Even an article pointing out semiconductor stocks which have gains of 24 to 41 percent for the month give credence to the thesis. The listed stocks performed very well in the short term. However, all of these seven listed stocks except for one have lagged the SOX over the last year and the recent gains just bring them closer to the sector returns for the time frame.

For investors who understand the cyclical nature of the sector, this stock would not be a bad choice to play the cycle. The company is nicely profitable even when sales are slow and profits will expand as the sector hits the upside of the cycle. Investor should keep an eye on the SOX and monitor the revenue trends of the major semiconductor stocks to determine the current direction of the cycle for the semiconductor sector. The up leg of the sector cycle can last two years or more and the down leg typically lasts less than one year. As an added bonus, Linear Technology recently increased the quarterly dividend and at the current share price the stock yield is 3 percent. If the report from Linear Technology concerning an upturn in sales is reflected in the results from other companies in the sector, a new bull market for semiconductor stocks may be just getting underway.