In some respects, analog chips are the workhorses of the semiconductor world. When the chip market goes into its regular troughs, the analog makers like Analog Devices (NYSE:ADI) batten down the hatches, and prepare for a few quarters of sequential earnings decline before the inevitable stabilization and recovery. Although the global economic situation is precarious, Analog may largely be through the process of seeing order levels reset ahead of a recovery.

Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.

A Tough Close to a Challenging Year
There wasn't all that much good news in this fiscal fourth quarter for Analog Devices. Revenue fell 7% from last year and 6% from the preceding quarter. Sales were weakest in the industrial and communications categories, where both saw double-digit year-on-year declines. Sales to automobile manufacturers were quite strong, though, and sales to the consumer category were mixed - better from the fiscal third quarter, but down from last year.

One of the persistent worries about the major analog chip companies (including Linear Technology (Nasdaq:LLTC) and Microchip Technology (Nasdaq:MCHP) is the health of margins. To that end, the roughly three-point decline in gross margin from last year and last quarter was not great, but it has been worse in prior down cycles. Operating income fell by mid-teens percents on both comparisons, and the company saw about four points of operating margin erosion. (To know more about income statement, read Understanding The Income Statement.)

Still Ample Reason to Worry
Analog Devices matched most of its big chip peers in lowering guidance for the next quarter. What is somewhat worrying about these results is how broad the declines are. The annual and sequential comparisons were largely equal across all major product categories like converters, amplifiers and digital signal processors.

What's more, the improvement in the auto business needs to be seen in the context of the disruptions from the earthquake and tsunami in Japan, almost a year ago. And then there's the consumer business - that year-on-year decline seems like a warning that this won't be a great Christmas for consumer electronics.

The real question is whether customers have basically reset inventories and order levels to a sustainable level. That's often the big question for analog makers - both the Big Three and smaller players like Avago Technologies (Nasdaq:AVGO), Fairchild Semiconductor (NYSE:FCS) and ON Semiconductor (Nasdaq:ONNN). When economic activity picks up, customers over-order and take on inventory to make sure they have enough components. When activity slows, they burn through those stored up chips.

Most industrial companies seem to be cautiously optimistic about the next year, and see continued growth on the back of a strong emerging market demand. If so, that should be good news for the likes of Analog Devices, Linear and ON Semiconductor - companies with large industrial exposure and double-digit sales declines recently in this category.

The Bottom Line
If chip stocks are bottoming, then there are plenty of recovery plays to consider. The trouble with the analog category, and Analog Devices, is that it's not an area of the chip world that attracts most tech growth investors. These stocks don't generally get pounded quite so badly in the declines, but they also don't rebound nearly so much in the recoveries - and those worries about the sustainability of margins seem ever-present.

Analog Devices is a fine, undervalued company and arguably a decent play on the eventual chip sector recovery. Moreover, if the global economy doesn't really rebound much in 2012, there is probably less downside here than in hotter chip names. Altera (Nasdaq:ALTR), Atmel (Nasdaq:ATML) and Cavium (Nasdaq:CAVM) may have more potential in a rising market, but investors unwilling to commit fully to the recovery thesis might want to have at least some funds in a more conservative play like Analog Devices or Linear Technology. (For additional reading, check out: Great Company Or Growing Industry?)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  2. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  3. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  4. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  5. Investing News

    Chipotle Served with Criminal Probe

    Chipotle's beat muted expectations and got a clear bill from the CDC, but it now appears that an investigation into its E.coli breakout has expanded.
  6. Stock Analysis

    Analyzing Sprint Corp's Return on Equity (ROE) (S)

    Learn about Sprint's return on equity. Find out why its ROE is negative and how asset turnover and financial leverage impact ROE relative to Sprint's peers.
  7. Stock Analysis

    Why Alphabet is the Best of the 'FANGs' for 2016

    Alphabet just impressed the street, but is it the best FANG stock?
  8. Investing News

    A 2016 Outlook: What January 2009 Can Teach Us

    January 2009 and January 2016 were similar from an investment standpoint, but from a forward-looking perspective, they were very different.
  9. Mutual Funds & ETFs

    3 Vanguard Equity Fund Underperformers

    Discover three funds from Vanguard Group that consistently underperform their indexes. Learn how consistent most Vanguard low-fee funds are at matching their indexes.
  10. Investing News

    Alphabet Earnings Beat Expectations (GOOGL, AAPL)

    Alphabet's earnings crush analysts' expectations; now bigger than Apple?
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
Trading Center