The Long Case for Semi Stocks

45-30-10-20-Hike! This is a reference to the GICS system, as I intend to take a closer look at the Semiconductor group (sub-industry 45301020), quite possibly the most overanalyzed of all sectors. I have been bullish on the group, though it has been a long wait for any sort of satisfaction. My interest in the group stems primarily from the demand that stems from the pervasiveness of the devices and their continually falling prices, though I am always wary of supply. There are some companies with incredible balance sheets and well-defined niches, and valuations are reasonable. I am not so sure that the stocks in general are great long-term investments, but they can provide very powerful intermediate moves.

With the stellar moves by Intel (INTC) last week and Texas Instruments (TXN) and Altera Corporation (ALTR) yesterday, one has to wonder if this is the end or the start of a trend. Will money flow into the group? There has been a lot of shorting of the group (macro plays) and long investors could play catch-up if they are underweighted, but the key to unlocking the answer to that question most likely depends on a question I won’t address here: Is the inventory correction over – are we entering a period where the demand will be met by new production?

What I will address here is an observation that the group is very reasonable and not overdone. Below is a list of 30 stocks in the semiconductor space, comprised of companies based in the U.S., market caps in excess of $1 billion, total debt-to-cap below 35%, and PE below 50. The data is as of 4/23, so the 8% moves in ALTR and TXN aren’t reflected:

click to enlarge

While I am not a huge fan of all of these companies, all of them are capable of big moves and several of them are truly exceptional companies. The group has a median PE ratio of 22.6, a little below the median of the past 5 years. A look at two other measures, P/B and P/S indicate similarly that valuation isn’t stretched. Looking at the price changes, the group is up about 8% year-to-date, not too far from the overall market. It certainly isn’t overbought, as measured by StockVal’s Price Momentum Index. Looking at the balance sheets, one finds what has to be one of the least leveraged industries around: very little debt and tons of cash. Finally, while dividends are pretty new for the industry, their presence could help expand the universe of investors who might begin to appreciate the maturity (and hence less volatility) of the industry. Below are some charts that reflect the history of these 30 stocks (weighted equally in terms of dollars).

1 yr chart - looks good:

10yr view - no valuation issue:

Not overbought:

Perhaps the estimates have bottomed:

Conclusion

The group is moving, and the list above has some very high-quality companies within it. Valuation isn’t extreme, short-term price momentum is now positive (though not extreme) after a very long period of underperformance and expectations are clearly muted. I am betting (see below) that the group will see some more upside.

Disclosure: Author is long ALTR, SIRF and TXN