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A Few Solid Reasons Why This Stock Should Be in Your Portfolio

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

Having a well-diversified semiconductor company in your portfolio can help your returns improve. Why? Because semiconductors are the basic building blocks of a number of things around us, ranging from a tiny calculator to an aircraft, and so, having a company which makes chips that are sold to various end-markets is a good idea.

One such company is Xilinx (NASDAQ: XLNX), which makes programmable chips that are used across various end-markets such as communications, automotive, industrial, defense, etc. The company has been on a roll this year, appreciating a tad over 30%, while also paying a dividend that yields 2.20% annually.

This solid run this year has stretched the company’s trailing P/E to almost 25 times, which might look expensive, but is still below the industry average of 26 times. But, the business has been picking up pace of late and Xilinx’s latest results, which were released around mid-July, indicate that there’s more room to run.

Going strong

The recently-reported first quarter results revealed that Xilinx beat estimates quite handsomely, as I’d expected. Although revenue was almost flat from last year at $579 million, it was miles ahead of the $549.3 million consensus estimate. On earnings, the company comprehensively beat the estimate of $0.47 per share by earning $0.56 a share in the quarter.

Remarkably, profit of $157 million in the quarter was around 20% up from the year-ago period, even though revenue was flat, signifying that Xilinx’s efforts to improve gross margin are bearing fruit and tricking down to the bottom line.

With such a solid performance in the bag, Xilinx didn’t disappoint with its guidance either. Well, when the end-markets are doing well and the company is doing its best to tap them with its impressive product development moves, then there’s no reason why Xilinx shouldn’t do better in the future.

Innovation driving growth

The company’s new product families, especially the 28-nanometer, the 40-nanometer, and the 45-nanometer chips, have been on a tear. Sales of new products jumped an impressive 75% in the previous quarter from last year as they found more traction in the market. But, the company isn’t stopping here and is looking to push the envelope with a 20-nanometer product family as well.

Xilinx is intent on staying ahead of the competition, and its latest innovations, such as the industry's first ASIC-class programmable architecture known as UltraScale, are focused on delivering better performance.

Telecom -- A big catalyst

Armed with its cutting edge chips, Xilinx is looking to capture the growing communications and data center market (which accounts for 44% of overall revenue), which should present it with a big opportunity given the expansion of LTE networks by various telecom carriers. More importantly, the company is banking on the two most important telecom markets in the world -- North America and China -- to benefit from LTE expansion.

For instance, LTE rollout in the U.S. has been heating up, with the likes of AT&T and Verizon occupying pole position and others, such as Sprint (NYSE: S), trying to make a dent in the market. Sprint’s acquisition by SoftBank has given it more resources to expand its LTE network, and SoftBank will be giving Sprint $16 billion to spend on the expansion over the next two years.

This investment will put Sprint’s LTE rollout in a higher gear and enable it to move into more markets apart from the 90 cities that are currently covered by its LTE network. Sprint has the required spectrum and as it spends on base stations, the demand for programmable chips which Xilinx supplies should improve further.

Similarly, in China, the deployment of LTE by China Mobile (NYSE: CHL) and China Telecom is expected to drive growth further. Xilinx believes that LTE activity in China will result in revenue gains later this year, and this is a reasonable expectation when we take a look at the moves that China Mobile is making.

Late in June, China Mobile launched a big LTE tender for supply of equipment for 207,000 base stations in 31 provinces, and it happens to be the biggest one ever in the telco’s history, according to China Daily. The same source reports that China Mobile would be bumping up its capital expenditure budget by almost 50% this year to $30 billion, with half of it expected to be spent on the carrier’s TD-LTE initiative.

More goodies

After the communications business, industrial, aerospace & defense is the next most important segment for the company with revenue share of 37%. In the previous quarter, sales from this segment improved 10% on a sequential basis, primarily driven by a government defense program. This segment is expected to improve in the ongoing quarter as well, but it should be taken into account that this segment is affected by the strength of the economy.

As reported by Bloomberg Businessweek, a Senate panel recently approved a defense spending bill for next year, with a focus on overturning the impact of sequestration. In addition, semiconductor companies are witnessing strong demand in the industrial and automotive end-markets, according to JPMorgan (sign-in required).

The bottom line

Considering these, Xilinx’s guidance for a sequential improvement in revenue to $579 million to $596 million in the second quarter was not surprising, and furthermore, this guidance was well ahead of the $562.6 million analyst estimate at the mid-point.

So, with further improvements expected going forward and a solid guidance to back up that expectation, I believe that Xilinx’s appreciation can continue and there’s no reason why investors should cash out by just taking a look at the P/E ratio.

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Harsh Chauhan has no position in any stocks mentioned. The Motley Fool owns shares of China Mobile. 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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