Look To Semiconductors For Earnings Growth

By Investopedia Staff | May 26, 2010 AAA

This most recent correction in the world financial markets has left many investors wondering whether the markets recovered too much too fast since their March '09 lows. While the S&P 500 has lost 8% in the past week, the technology sector fell a mere 1.5%, showing resilience thus far in the face of what many fear could be an extended correction. Pundits and analysts are recalculating the fundamentals that were once so promising, but the fundamentals for the technology sector, namely in the semiconductor industry remain strong.

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The computing industry is expecting growth rates in the double-digits for the coming year, according to the May 6 press release from iSuppli, a market research firm specializing in electronics value chain. The majority of the anticipated growth is expected to come from the internet, especially in emerging markets where social media continues to grow at a rapid pace.

As well, with the recent emergence of mobile and handheld devices, the semiconductor firms are primed to capitalize on the mobilization of the internet in the coming years. Below are a few chip companies that could be good bets to not only withstand a prolonged correction period but perhaps even thrive in it.

Intel Is Number One
The overwhelming favorite amongst analysts in the semiconductor industry has to be Intel (Nasdaq:INTC). The chip giant has returned to profitability in the past nine months and hasn't looked back, topping analysts' earnings estimates in each of the past three quarters. In its recent Q1 conference call Intel announced revenue growth of 44% to $10.3 billion over the same period last year, and increased gross margin to 63.4%, up nearly 18% from Q1 2009.

During their recent analyst day meeting CEO Paul Otellini laid out goals for low double-digit revenue and EPS growth in the next few years, which was taken as a positive sign by the analyst community. Otellini also pegged overall PC growth at roughly the same rate.

Intel is also trading at an extremely low forward P/E of 10.5x, near the low-end of its historical rate of 10-25x according to Suji De Silva Kaufman Bros. Such strong fundamentals combined with being the dominant player in the semiconductor landscape, which is expecting its highest annual growth rate since the internet bubble blew, Intel looks like it could outperform both its sector and the market as a whole.

A Surprising Second
Intel's biggest rival in the semiconductor space AMD (NYSE:AMD), has outperformed even Intel when it comes to earnings surprises. While analysts expected the chipmaker to stay in the red until Q1 2010, AMD shocked the market by posting a $1.52/share profit in Q4 2009 when consensus estimates had the firm losing $0.18/share. AMD followed up that trumping by doing the same thing in its most recent quarterly numbers, earning $0.09 to an expected $0.05 loss; although not as definitive, it's still a sign of tremendous earnings growth. AMD is targeting a 38% growth rate in the coming year, which far outpaces Intel in relative terms.

Additionally, Hewlett Packard (NYSE:HPQ), which recently purchased Palm (Nasdaq:PALM), just released their back-to-school notebook lineup; this is the single largest launch of a notebook lineup with a dedicated AMD processor. However even with the strong recent results and future growth prospects, analysts are quick to point out that AMD's product line-up is not on the same level as Intel's and that the company's growth rate should fall back in-line with industry levels in the coming years. AMD could prove to be a profitable underdog for investors willing to take the risk, however, review the company's prospects thoroughly before making that decision. (For more investment ideas, check out Sales Up In Semiconductors.)

Beating Expectations
Much like AMD, NVIDIA (Nasdaq:NVDA) is another chipmaker that has enjoyed an incredible sales rebound in the past year but comes with some concerns about its future prospects. NVIDIA has shown profitability during the recent uncertainties of 2009, and is set up to more than double earnings in fiscal 2010. In its most recent quarter NVDA grossed over $1 billion in revenue, not only topping analysts' estimates but reaching a pretty significant psychological benchmark as well. Earnings also beat expectations, turning a $0.37/share loss in the same quarter a year ago into a $0.23/share profit. A major contributing factor to this reversal has been that NVIDIA has managed to grow gross margins in five consecutive quarters, a sign of strong sales and effective cost-cutting.

However, analysts question the forward earnings potential for the firm much like they do AMD, namely because Intel is such a force in the industry. NVIDIA also didn't do itself any favors by lowering expectations for next quarter, anticipating revenues to drop between 3-5% from Q1 levels. Next year the company is still expecting earnings growth in the low double-digits but beyond that your guess is as good as mine. NVIDIA should benefit from a growing industry in mobile computing, but the firm relies a great deal on gaming and video to drive profits. This is another stock that investors need to study up on in order to make an informed choice about its future prospects.

The Bottom Line
The semiconductor industry is one of the few sectors that is expecting double digit growth rates in the coming years. Intel is definitely the alpha-dog in this space and should provide investors with steady earnings; however, AMD and NVDA could potentially outperform Intel in terms of their stocks if they are able to make up market share from the industry leader. (For more, check out Follow The Smart Money For Sinful Returns.)

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