2 Semiconductor Stocks to Buy, 1 to Avoid
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Given the intense innovation coming out of technology, it should not be surprising that competition has picked up in the semiconductor industry. This will make for "winners" and "losers" in the next few years. Accordingly, I recommend carefully watching how management makes inroads into new markets or exits old ones. The key is to back firms that show confidence in the markets that they are penetrating.
When it comes to value in tech, I believe that Intel and Broadcom come close to topping the list. After falling from $29 in early May to under $23 today, the former now trades at a respective 9.6x and 10.4x past and forward earnings. To put this into perspective, consider that the PEG ratio currently stands at 0.90, which indicates that this brand name stock has not fully factored in growth.
Assuming the company is able to grow EPS by 10.7% annually over the next five years, 2016 EPS will come out to $2.97. At a multiple of 16x, this translates to a future stock value of $47.52 - more than double the current market assessment. Discounting backwards by 10% yields a present value of $29.51. This provides a substantial margin of safety on top of a terrific 4% dividend yield. If there ever was a time to invest in Intel, it is now.
Now, because of several reasons. The company is creating inroads into its Atom CPU market through building Atom reference designs that offer Internet-accessible storage. In addition, the speculation that Apple may somehow abandon Intel has irrationally beaten down the stock. The multiples are likely to move much more if the speculation proves false than if it proves true. In addition, Intel has a strong venture capital business that the market fails to appreciate. It recently invested $40 million in 10 private technology producers that range from cloud storage developers to Chinese mobile ad networks. This exposes the company to much greater upside than what the market has accounted for.
"Broadcom" may ultimately not have the same ring to it as "Intel," but it's still undervalued. At 11.2x forward earnings, the stock is rightfully rated a strong 1.9 out of 5 on the Street, where 1 is a "buy." At a beta of 1.3, the sock has recovered from its local low in mid-July and is inching forward towards the $41.60 price target.
Fortunately, the company has a consistent track record and is now gaining exposure to the key mobile developers, like Apple (15% of business comes from the tech producer). Thus, where Intel is starting to fall slightly, Broadcom is picking up the pieces. Growing market share in mobile is particularly beneficial given the strong secular trend towards greater innovation, as data plans and unmet iPhone 5 demand can attest to.
Texas Instruments (NASDAQ:TXN): When Good is Bad
TI may be a great company led by terrific management, but everybody knows that. Consequently, the stock is overvalued at 20.6x past earnings. Analysts recognize this and thus rate the stock closer to a "sell" than a "buy." But even they, in my view, are too optimistic given the forecast for annual EPS growth, which is 3.5x faster than what was achieved in the preceding five years.
In addition, I am also concerned about the company's decision to take the focus away from its mobile app processor when secular trends in end markets have proven strong as a whole. Oppenheimer rightfully has argued that this will create top-line headwinds in the TI wireless segment, which already represents a tenth of TI's business. This puts a damper on the growth story and will likely result in continued margin compression even in the context of better-than-expected results.
While management has generally consistently boosted free cash flow and returned it to shareholders, future growth opportunities look bleaker against rising competition. Accordingly, I recommend holding out and buying competitors Intel and Broadcom.
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