Are You Playing the Semiconductor Industry Correctly?

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Applied Materials (NASDAQ: AMAT) provides manufacturing equipment for semiconductor companies. The tech company offers products for front-end and computing applications. The slowdown in the PC and computer markets has pressured this space, given that over two-thirds of semiconductors are used in PCs. Billionaire Steven Cohen of SAC Capital added Applied Materials to his portfolio last quarter (check out Steven Cohen's top picks).

Applied Materials is expected to still see weakness with sales down 10% in FY2013 after a 12% decline in FY2012. Generally speaking, middle-market semiconductor companies are struggling due to declining growth opportunities. Research firm Gartner expects below-average growth rates for the tech firm’s silicon business, which makes up about half of Applied Materials’ total business. Issues in the solar industry should continue to be a drag on the company, with mobile devices being the obvious driver. This bullish trend will be supported by the adoption of LTE networks in developed nations, including the network's rapid adoption in the U.S.

From a valuation standpoint, Applied Materials has seen major pressure related to continuing restructuring actions, which now has the stock trading at over 100x earnings. Applied trades the cheapest on a P/S basis, at 1.7x sales, and is also one of the cheapest on a forward P/E basis, at 13x. This is, however, for good reason, given that its long-term earnings growth rate of 9% is the lowest in the industry.

What about its competitors?

KLA-Tencor (NASDAQ: KLAC) pays one of the best dividends in the chip-making business at 3.3%, with only a 35% payout. KLA is also one of the cheapest tech stocks of the five listed here at 11x earnings and 2.6x sales. The semiconductor equipment company has modest growth, similar to Applied Materials, at a 10% 5-year EPS earnings growth rate. Billionaire Ken Griffin, founder of Citadel Investment Group, was selling off a large part of his stake last quarter, dumping 99% of his shares (check out Ken Griffin's newest picks).

Qualcomm (NASDAQ: QCOM) is one of the top semiconductor giants that has above-average growth prospects (15% 5-year expected earnings growth) due to its exposure to the smartphone market. Holding Qualcomm back is its limited dividend yielding 1.6%, though it isn't overly expensive at 20x earnings and 5.5x sales.

Intel (NASDAQ: INTC) is one of the cheapest tech companies around at a PEG of 0.8. Intel pays a handsome dividend yielding 4.3% on only a 35% payout and is also the cheapest stock among the five listed here, at a 9x P/E and a low-end P/S of 1.9x. Although the company has issues with a declining PC market, it still has the highest EBITDA margins in the industry at 43%.

Texas Instruments (NASDAQ:TXN) is a third the size of Qualcomm and Intel, but has much lower growth than Qualcomm at a 10% 5-year annual EPS growth rate. We are also not encouraged by Texas' 2.7% dividend yield given its high 44% payout ratio. Many top-name billionaires fell out of love with Texas Instruments during the third quarter, including Jim Simons, Ken Fisher and Ray Dalio (see Ken Fisher's top bets here).

To recap: Applied Materials has solid potential after a tough transitional period. The tech company is up close to just half that of the NASDAQ composite on a year to date basis. The recent performance and earnings of Applied have been weak, and Intel, Qualcomm, and KLA look like better investments at the moment.

This article is written by Marshall Hargrave and edited by Jake Mann. They don't own shares in any of the stocks mentioned in this article. The Motley Fool owns shares of Intel and Qualcomm. Motley Fool newsletter services recommend Intel. 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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