Get Ahead of Semiconductor Industry Growth with These Seven Investments

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The semiconductor industry struggled to maintain growth in 2011 - but that's starting to change.

The industry this year was stunted by slow global economic growth, reduced consumer demand, and supply-chain disruptions due to the Japanese earthquake and tsunami. Industry revenue was down 2.5 percentage points in the second quarter, mostly due to Japanese semiconductor companies that suffered facility damage.

While the industry's third-quarter performance was weaker than predicted, it was an improvement over previous quarter numbers. According to estimates released Nov. 17 by market researcher IHS iSuppli, semiconductor industry revenue in the third quarter grew by 3.5% to just over $78.5 billion.

Forecasts for the next two years offer an even brighter outlook.

The Semiconductor Intelligence blog compiled forecasts from eight industry research organizations and found growth estimates for 2012 ranging from 4.0% to 10.4%.

Industry executives expressed similar optimism at an investor conference Nov. 15 in Barcelona, Spain. They forecast a "return to normal business conditions in the second quarter of 2012," once inventories of unsold chips stemming from the slowdown in consumer spending are cleared.

And IHS predicted a much stronger growth rebound in 2013.

Intel Corp. (Nasdaq: INTC) President and Chief Executive Officer Paul Otellini said that, while economic conditions and consumer demand will always be a factor, innovation is driving renewed growth in the semiconductor industry.

"Computing is in a constant state of evolution," Otellini told this fall's Intel Developer Forum in San Francisco. "The unprecedented demand for computing from the client devices to the cloud is creating significant opportunity for the industry."

Investing in the Semiconductor Industry

While the semiconductor industry's top performers have shown modest gains from a year ago - Intel's 14.3% rise being one example - bigger declines elsewhere have offset the winners. That inconsistency within the broad semiconductor sector - Google Finance lists 189 companies on its industry roster, divided into roughly a dozen subsectors - is why some chip stock investors are frustrated.

The good news for investors is there's an increasing need for semiconductor companies that's not going away. Chips are now essential to virtually every product that uses power, from mainframes, PCs and laptops to TV sets, video-game consoles and mobile phones. Without chips, modern cars won't run, airplanes can't fly and many now-routine medical procedures would be impossible.

The key for investors is to focus on companies in the most in-demand subsectors, as well as industry leaders best positioned to profit from renewed growth in 2012 and 2013.

It's the subsector performance that holds the industry's potential for a rebound in 2012, with 15% growth projected in microprocessors, image sensors and NAND flash memory segments. Sensor and actuator sales will grow more than 5%.

Investors also should consider the sector's smaller, more specialized players, which at their current low prices are great candidates for merger & acquisition (M&A) activity.

According to the Thomson Reuters Investment Banking Scorecard, M&A activity in the semiconductor industry has more than doubled in 2011, rising to a total of $30.9 billion, a 111% increase over the same period in 2010. Overall, total M&A activity for 2011 has reached the highest level since 2006.

Even though analysts expect M&A activity in the sector to remain somewhat subdued in the first quarter of 2012, the expected increase in industry-wide product demand could spark a new surge in takeovers in the second quarter.

Seven Ways to Play the Semiconductor Industry

As the semiconductor industry picks up growth again, here are five stocks we like now:
  • Microchip Technology Inc. (Nasdaq: MCHP), recent price $34.91 - Microchip develops controllers with reprogrammable memory technology. The bulk of its sales are to other semiconductor companies, meaning its revenue is among the sector's first to grow when an upturn begins - making it an industry bellwether. The company reported a slight third-quarter drop in both revenue and profits (40 cents per share), but analysts expect an upturn in the fourth quarter and stronger performance in 2012, possibly leading the stock back to its 52-week high of $41.50. It pays a dividend of $1.40, good for a 4.1% yield.
  • NVIDIA Corp. (Nasdaq: NVDA), recent price $15.48 - The inventor of the graphics processing unit (GPU), which makes speeds up the visuals of computers, smartphones and numerous other devices, is a supplier for electronics-equipment (OEM) makers worldwide. The stock closely tracked the SOX Index for most of the year, topping above $26 a share in February, then falling to $11.47 in early October. However, it bounced nicely early in the quarter, getting a boost from its third-quarter earnings report, which showed a rise in profits to 29 cents a share, up from 25 and 22 cents in the prior two quarters.
  • Avago Technologies Ltd. (Nasdaq: AVGO), recent price $31.04 - Based in Singapore, Avago designs and develops analog semiconductor devices, offering more than 6,500 products for firms worldwide. The company, which ranks 20th in terms of global market share, reported revenue of $603 million and profits of 57 cents a share for its most recent quarter, up from 54 cents and 48 cents in the prior two periods. Analysts estimate current full-year profits will total $2.68 a share and climb to $2.83 next year. The average one-year forecast for the stock is $39.29, taking it back to its 2011 high set in July. The stock pays a small dividend, yielding just over 1%.
  • Xilinx Inc. (Nasdaq: XLNX), recent price $33.36 - Silicon Valley-based Xilinx was one of the steadiest sector performers during the 2008-2009 economic collapse. Xilinx, which makes programmable logic devices for a variety of uses, in its 2011 fiscal year reported a big revenue jump to $2.37 billion. Though earnings slipped a bit in the most recent quarter, analysts remain positive overall, with 12 of 27 surveyed ranking the stock a "Buy" and the rest advising investors to hold. The stock pays a $0.76 dividend, providing a yield of 2.3%.
  • Intel Corp. (Nasdaq: INTC), recent price $25.01 - It's hard to bet against No. 1, and that's Intel's position in the chip sector - by a wide margin. With 2010 revenue reaching more than $40 billion, Intel controlled 13.2% of the chip market, and that dominance is expected to grow as it continues to grab larger shares of the notebook and smartphone markets. Its processing and power units are also getting stronger at a pace well ahead of the rest of the industry, ensuring continued growth. With earnings projected to climb to $2.57 a share in 2012, the stock is rated "overweight" or "hold" by 45 analysts surveyed by MarketWatch. The stock also pays a dividend of 84 cents a share, giving it a healthy yield of 3.4%.

    Intel is working on a number of innovations, including technology that increases battery life and aids in the new age of "always-on, always-connected" computing, and a chip "that could allow a computer to power up on a solar cell the size of a postage stamp." Otellini also announced a new joint venture with Google Inc. (Nasdaq: GOOG) that will accelerate Intel's penetration into the smartphone market.
For investors who prefer a more diversified approach to playing the sector, two exchange-traded funds (ETFs) worth a look are:

  • iShares PHLX SOX Semiconductor Sector Index Fund (Nasdaq: SOXX), recent price $51.30 - This fund holds 52 stocks, weighted based on market capitalization, roughly tracking the Philadelphia Stock Exchange's Semiconductor Index. Its largest holdings are Intel, Broadcom, Applied Materials, Texas Instruments and Altera. Its expense ratio is 0.48%.
  • SPDR S&P Semiconductor ETF (NYSEArca: XSD), recent price $46.32 - This fund holds 63 securities in the chip industry, with holdings equally weighted and regularly rebalanced - unlike other chip ETFs, which are all capitalization weighted. The fund's expense ratio is 0.35%.
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