Chips: You Can’t Have Just One, But Some Should Be Avoided

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

I don’t believe that there’s a sector that can’t wait to get this brutal year over with more than chip companies. Aside from a few standouts such as Qualcomm (NASDAQ: QCOM) and ARM Holdings, the entire group has been ravaged by poor earnings and meager guidance.

Although I think there is cause for optimism as the New Year approaches, I think astute investors would be wise to jump into some of these names now. What better reason is there other than the fact that they are cheap? But the challenge is trying to figure out which ones have the best potential, especially since some have similar weaknesses and advantages.

The Deciding Factors

However, in trying to decide which chip companies to buy, it’s hard to not consider their exposure to the mobile devices market. Plus, this also start the process of elimination. Unfortunately, this all but excludes Intel (NASDAQ: INTC), which is now trying to find a successor to the company’s outgoing CEO, Paul Otellini, who recently announced his retirement - although I have my own thoughts about this situation, which I've recently shared here.

Nevertheless, it was Intel's struggles to adapt to new markets and its inability to anticipate the rise of mobile devices that led to the recent dominance of Qualcomm and ARM Holdings. In that regard I see both companies as undervalued from their true potential.

What's more, with Apple (NASDAQ: AAPL) expected to report a monster quarter in January, I expect shares of both Qualcomm and ARM to appreciate in short order – Qualcomm in particular. But for Qualcomm, it’s not all about Apple. Surprisingly, the company rarely gets mentioned when discussing some of the best run operations on the market today.

The company is in a fast growing mobile market that has yet to peak. Better yet, in Qualcomm's most recent quarter, not only did revenues soar 18% year-over-year to $4.87 billion and beat analysts’ estimates, but remarkably, the company reported a 1% jump in chip shipments. This is while other names such as Texas Instruments and Atmel were revising lower.

What remains impressive about Qualcomm is that 2013 is poised to be an even bigger year, a notion that is supported by the fact that management recently raised revenue guidance. As a result, I would be adding shares here in anticipation of a pretty good payday sometime in the first quarter.

For similar reasons, I would be accumulating shares of Broadcom (NASDAQ: BRCM). The company is in the midst of becoming a remarkable turnaround story – except nobody is talking about it. Although the stock is not cheap by any means since it is trading at a considerable premium to Qualcomm (P/E of 18 vs. 25), Broadcom still has plenty of room to run.

As with Qualcomm, not only has Broadcom been beating estimates each quarter, most recently the company produced over $2 billion in revenue – in one quarter. This was a 9% increase year-over-year. Working in the company’s favor is that it has close ties with both Apple and Samsung - an advantage that some of its peers don't get to enjoy.

What this means is that Broadcom has a combined 50% exposure to the smartphone market. As I noted above, it is still a market that is growing and has yet to peak. But it’s not all about chips either. Broadcom is also dominant in the network enterprise arena, where one of its biggest customers is none other than Cisco.

Another stock that deserves consideration is Nvidia (NASDAQ: NVDA). But unfortunately, the company is finding it difficult to convince Wall Street that it can transform itself from a legacy video chip operation for PCs into a legitimate mobile player.

Although the Nvidia’s Tegra line of chips have been gaining some traction, it has not been enough to please analysts. This is even though in its most recent quarter the company beat on both its top and bottom lines. Its growing revenues and net income suggests that the company is stealing market share from Texas Instruments and Advanced Micro Devices.

Likewise, Nvidia's better than expected earnings performance should serve as evidence that the company is able to do exactly what the Street says it can’t. Smart investors would be wise to jump on these shares that are significantly undervalued compared to their true potential. For Nvidia, I suspect after one more quarter of solid growth, Wall Street will have no choice but to believe.

Bottom Line

Chips have always been one of the best derivative plays on the market. This was the case when Intel and AMD rode the coattails of Microsoft as well as some of the biggest PC names over the past decade. They experienced enormous growth by merely being “inside” the machines.

Today, in many respects, the same is true – except mobile devices are now dominating the market. While the names are abundant, only a few will be able to produce market beating performances. I’ve provided a few names, but making money on your investments requires having a real understanding of the advantages that each of these companies present.

rsaintvilus is long AAPL and has no positions in the other stocks mentioned above. The Motley Fool owns shares of Apple, Intel, and Qualcomm. Motley Fool newsletter services recommend Apple, Intel, and NVIDIA. 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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