Why You Should Buy This Risky, Expensive Stock

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

In light of all the innovation in technology end markets, semiconductors have exceptional demand to meet. In this environment, I recommend buying stocks based off of share gains, success in R&D, multiples, and exposure to high growth markets. With these factors in mind, I review several semiconductor stocks below.

Avoid Advanced Micro Devices (NYSE: AMD) for This Stock

As anyone watching could tell you, AMD has been on a dramatic downfall. It has fallen 77% from its 52-week high and is still rated a "sell" on the Street. Free cash flow generation has been on and off--breaking into positive territory then negative territory and back again over the last three years. Even the core CPU/APU business has lost $114 million in the recent quarter. Perhaps worse yet is the reason why sales were so bad: the company lost 270 bps in market share and saw concomitant margin pressure. Industry is transitioning to more efficient systems, and this will provide strong gains for Intel (NASDAQ: INTC), not AMD.

AMD has also seen market share in desktop computers fall to 35.7% from 40.7% while market share in notebooks skydived to 34.2% from 44.8%. Intel, on the other hand, continues to gain market share. In fact, the chip producer increased its stake in the semiconductor market to 15.6%--the highest in a decade. This increased penetration was achieved through rising demand for PC-oriented microprocessors, NAND flash memory, and wireless--the last of which grew through the acquisition of Infineon's wireless segment.

My one main concern with Intel is that its R&D keeps going up and up, but yet its free cash flow remains highly volatile. Over the last 5 years, R&D expenditures increased by 70.8% to $9.8 billion while free cash flow only grew 6.5% to $8.1 billion. Even still, this is much better than AMD's trajectory, and the weakness has been more than reflected into the stock price. Intel now trades at only 8.6x past earnings and a PEG ratio of 0.81x. The chip manufacturer has had a historical 5-year average PE multiple of 16.9x, so it would be highly for multiples to contract even more. With a dividend yield of 4.6%, I strongly recommend buying Intel over AMD.

Maxim Integrated Products (NASDAQ: MXIM) Risky, Not Cheap, But Has Catalysts

In contrast to Intel and more along the lines of AMD, Maxim is a risky semiconductor producer in the broad line space. It trades fairly high at 24.1x past earnings, but offers a reasonable dividend yield of 3.4%. Analysts forecast EPS growing by 13.5% over the next 5 years. Assuming expectations are met, 2016 EPS will come out to around $3. At a multiple of 15x, this translates to a present value of $45. Discounting backwards by 10% yields a present value of $27.94--slightly below the current market assessment.

There are several reasons why one should still be optimistic about Maxim. Maxim is a leading Galaxy S III supplier, which has seen excellent results. 18 million S III devices were shipped, and they now control 10.7% of total smartphone shipments. To put this into perspective, only 5 million iPhone 5 units were shipped! In the third quarter, global mobile phone shipments grew 2.4% y-o-y but smartphone shipments grew 45.3% y-o-y. Not surprisingly, management beat analyst expectations in the most recent quarter and issued guidance targeting EPS between $0.39 - $0.43. The combination of smartphone design wins and tablet wins across several analog lines provides strong momentum. Maxim is solidly positioned in mixed signal and analogs, which are expected to outperform the broader chip market. If transistor costs decline as volumes rise, the business will be a huge winner.

Although I believe Maxim is worthy of accumulating shares, I still find Intel more attractive. The larger chip maker has lower multiples and a broader economic moat. Its free cash flow generation is strong and complemented by share gains.

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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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