Why You Should Buy These 3 Semiconductor Stocks

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

So much hype has surrounded the release of Galaxy S3 and iPhone 5 that, ironically, investors have lost touch of the companies that directly service these products: semiconductors. There are a few undervalued stocks out there that have excellent leverage towards secular transitions in the market. But what are the specific catalysts that could drive outperformance? Below, I review three companies that I believe will drive strong returns in the near- and long-term.

Early-Mover Advantage For Qualcomm

At a forward earnings multiple of 13.2x and a clean balance sheet, Qualcomm (NASDAQ: QCOM) looks like a solid investment. It is currently rated a 1.9 out of 5 on the Street where "1" is a "buy." Deutsche recently released its "buy" rating on the sock with a price target of $74. FBR Capital was even more optimistic with a price target of $77. Either way, we are talking about around a 20% discount to intrinsic value. The stock has picked up 21.8% from its 52-week low, so momentum is working on the value gap being closed.

There are several reasons why I am optimistic about Qualcomm. First, its decision to acquire assets of EPOS, since it positions the company to service touch screen electronics. The technology will likely be integrated with Qualcomm's existing Snapdragon processors, and, in this way, provide a software-based answer over competing solutions. Second, management believes it can grow EPS at more than a 10% rate over the next 5 years. With a focus on gaining Chinese baseband chip share, I believe this target can be achieved. Emerging markets are expected to drive 3G/4G connections to 2.7 billion by 2016, a 3.4x increase from 2011 levels.

With design wins in Galaxy S3, the iPhone, Nexus 4, and Nokia, Qualcomm has leading credibility amongst smartphone producers. In the recent quarter, average selling prices held steady, but Qualcomm was able to beat consensus estimates by generating faster-than-expected growth. Better yet, emerging markets are moving towards 3G, which is in turn providing another wall of support in the "smartphone success" story. Performance during the past 5 quarters has been on and off with 2 misses, but the stock has prevailed all the same - gaining 11.5% in the last 12 months.

Broadcom, Intel Also Undervalued

Broadcom (NASDAQ: BRCM), on the other hand, has plummeted 4.6%--underperforming the NASDAQ by around 1,800 bps. Strangely, however, Broadcom has beat expectations in 4 of the last 5 quarters with an average beat of 14.1%. And there are several catalysts that the company has going for it. Design wins, like touchscreen controller chips that are in the iPad Mini, have been reflected in solid Connectivity sales. In fact, in the most recent quarter, a record bottom-line of over $1 billion was reported in mobile & wireless. Revealingly, this division grew faster than the underlying mobile & wireless market.

Strong share gains in China are also a long-term transition to be optimistic about. But Broadcom owes its success in this region largely to many small customers, and these are, of course, not nearly as sustainable as the larger producers. On the flip side, it improves the company's bargaining power. In the high-growth smartphone market, Broadcom has said that customers will increase the number of higher-end smartphones with dual-core products in advancing quarters. With Texas Instruments exiting this market, Broadcom can help fill the void and thereby gain market share. My main concern with the firm, however, is that it has been slow to act. The crossover into 3G has left the 2G market to rot, and Broadcom was sadly unprepared for that transition. Even still, this is insignificant in the grand scheme of things, and, in fact, the net income contribution will amount to zero by 2013.

To supplement your investment in Broadcom, I encourage buying market leader Intel (NASDAQ: INTC). As any observe will tell you, the stock has been hammered in the recent months--it has fallen 29.5% from the 52-week high. But Standpoint Research, in their recent research report, expressed that they are bullish on the stock, and so am I. The PEG ratio is now well below 1x at 0.83x, and EPS growth is forecasted for a 10.6% rate over the next 5 years. Needless to say, multiples this low cannot be sustained in the long-term.

Furthermore, Intel has made inroads in key growth markets. The company's next-generation Bay Trail tablet CPU will use 22nm manufacturing to run an Intel HD 4000 GPU. This will showcase the company's abilities and help to gain market acceptance. Until then, the downside is relatively limited from a 4.4% dividend yield  and an excellent balance sheet.


TakeoverAnalyst has no positions in the stocks mentioned above. 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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