3 Undervalued Semiconductor Stocks to Consider Buying

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

As the technology market heats up, investors should strongly consider backing semiconductors. These producers are naturally well diversified in the sector and have been overly discounted from isolated past supply chain problems. Below, I highlight three producers that are worthy of a possible buy.

Intel (NASDAQ: INTC) Undervalued Despite Weak Outlook

At a respective 9.2x and 10.1x past and forward earnings, Intel is very cheap for such a compelling name. It offers a 4.2% dividend yield and a forecast for 10.7% annual EPS growth over the next five years. Tied with multiples expansion to the historical 17x PE multiple average, growth should send the stock soaring.

The stock fell 2.7% after the the third quarter earnings call, which featured weak forward guidance -- but still an earnings report that was slightly above guidance for the quarter. Goldman Sachs has forecasted weaker margins over the next 12 months or so; but I believe softness in China has been overblown. Efforts to reduce inventories as PC demand falls amidst cautiousness from OEMs will also help keep pricing elevated. Moreover, the growth in cloud computing and positive secular trends in data storage should drive sustainable streams of free cash flow.

$10 billion is expected to be spent on R&D in 2012, and Intel has a war chest of $10.5 billion in cash for takeover activity. Thus, I believe the company could make a move in mobile to capitalize on the smartphone craze. Meanwhile, the firm is gaining big in billings for the system production of Windows 8.

Management, however, is reserved on the near-term. It stated that overall PC business will be half of what would be expected through typical cyclicality. If anything, however, this should indicate to shareholders that the company is exploring multiple avenues to offset. Intel, according to the CEO, "has a history of navigating the industry's transitions and emerging better and stronger." The decision to cut factory loadings and redirect equipment to 14-nanometer, for example, showcases this flexibility.

Applied Materials (NASDAQ: AMAT) & Lam Research (NASDAQ: LRCX): Buy Based on Risk Preference

Applied and Lam are both considerably more speculative than Intel. The former trades at 15.1x forward earnings versus 9.3x for the latter. Both are rated a "hold" or worse on the Street and are exposed to tremendous competition in the semiconductor equipment & materials market.

If there is something to be optimistic about, it would ordinarily be Lam's 4Q12 earnings report, in which earnings came in above expectations. However, the outlook for $0.38 to $0.52 in EPS in 1Q13 was well below the $0.49 consensus. Despite this, the stock took off 5.4%. It is surprising that Intel, the stronger brand, fell despite having ultimately a very similar earnings call.

Applied is currently forecasted for 9.7% annual EPS growth over the next five years. The projections are just 30 bps greater at Lam, but then again Lam doesn't offer a 3.2% dividend yield like Applied does. It should be noted that Applied beat expectations in all of the last five quarters. By contrast, Lam has been more on and off. Thus, from a risk-averse perspective, I would easily go with Applied. However, Lam's low multiples and turnaround potential are highly compelling.

In the 1Q13 earnings call, Lam reported stellar results. Shipments of $935 million rose 15% sequentially as the customer base broadened across several segments. And while capacity additions have fallen this year, they are expected to rise in 2013 - in my view, over and above expectations. Furthermore, the company's NAND capacity is supported by growing demand for tablets, smartphones, and SSDs. Management is thus well prepared for a ramp up in n+1 technology node capacity additions.


TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Intel. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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