1 Semiconductor 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.

Semiconductors are facing two different worlds. In one, companies are positioned to exploit positive secular trends in computer, mobile, and tablet devices. In the other, the industry understands this and, as a result, is saturated with competition that is driving down profit margins. I recommend buying stock in those that are best positioned to hold their own and exceed analyst expectations...

Buy Broadcom (NASDAQ: BRCM)

There are several reasons why I would be compelled to buy shares in Broadcom. According to Morningstar, one main bullish thesis on the company is that its product diversity enables it to reduce volatility in an otherwise uncertain environment. Multiple contracts secured with leading mobile and handset further position the company for positive secular trends. Equipped with a well respected R&D department, Broadcom can also stay ahead of the increasingly innovative mobile curve. At the same time, innovation is causing operating systems to converge in functionality--note, for example, how the iPhone user interface has been more or less adopted by competitors. As the market share leader in mobile connectivity, Broadcom also benefits from greater user interactions.

On the flip side, there are several reasons why you should be bearish on the stock according to Morningstar. For one, competitive pressure from TI poses long-term margin problems. In addition, management has not been entirely friendly towards shareholders over its history. Public stock-option backdating issues and a highly compensated management go a long way in reducing investor confidence over their share of the cash flow. With a large cash chest, however, management should consider increasing scale through takeover activity. By sizing up against larger peers, margin pressure will be limited from a strengthened ability to price at premiums through multiple offerings.

Avoid Texas Instruments (NASDAQ:TXN)

While TI may be a premium semiconductor producer, it is fairly expensive at a respective 18.4x and 15.8x past and forward earnings with a dividend yield of 2.9%. Over the last 52 weeks, the stock has hovered between its 52-week low and 52-week high. Analysts forecast 10% annual EPS growth over the next half decade, which won't nearly be enough to make up for the flatness.

During the recent quarter, embedded processing fell 4% from last year as business declines in communications infrastructure apps. Wireless revenue fell 44% from last year with particular weakness in connectivity and baseband. Even the "Other" segment fell 11% from last year. With demand weak and management expecting this weakness to carry into this quarter, the upside story doesn't look bright from here. In addition, the softness is due to poor end market demand and not supply adjustments--more generally, today's problems are not isolated but more long-term. To play devil's advocate, there are several reasons why you should be optimistic about TI. With short lead times and flexible factories, the company can handle macro volatility. Moreover, management continues to be very shareholder friendly with its capital allocation policy. The dividend yield of 2.9% and low debt-to-equity ratio of 2.5x indicates a strong financial position and confidence over the future financial position.

All things considered, however, I am bearish on the company's ability to outperform. Competitive pressures have limited margin opportunities, and growth forecasts are at a rate several times higher than what was achieved in the past. I recommend avoiding on that reality. By contrast, Intel (NASDAQ: INTC) has achieved 22.8% annual EPS growth over the next five years but is only forecasted for a 10.6% rate over the next five years. Moreover, Intel trades at much lower multiples of 9.6x and 11.2x past and forward earnings, respectively. With the largest economic moat in the field at a $110.4 billion valuation and a much higher dividend yield at 4.1%, there is simply little reason to buy TI over Intel. I believe that as macro trends pick up, investors will start to realize this and cause multiples to equalize. That means downside for TI and upside for Intel.

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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