Tickers in this Article: ADI, LLTC, TXN, ALTR, MCHP, ONNN, BRCM
As in many other industries, semiconductor investors have a choice to make - go with the exciting secular growth stories, or stick by the proven winners. The first option is where the multi-baggers are found, while the second is arguably less risky. Although there is arguably no such thing as a safe semiconductor stock, investors may want to consider Analog Devices (NYSE:ADI) as a middle road between recovery and recession scenarios. (Dividend capture strategies provide an alternative investment approach to income seeking investors. See How To Use The Dividend Capture Strategy.) TUTORIAL: Forex Trading 101

A Tough Fiscal Third Quarter
While Analog had an unusually strong fiscal second quarter, the company gave some of that back this time around. Revenue was up 5% from last year, but down 4% from the prior quarter and a little below the bottom end of the company's guidance range. Results were hurt most by weakness in the communications business, but industrial and auto sales were weak as well. Consumer sales were stronger (up 5% sequentially), but this represents less than one-fifth of total revenue.

It is to Analog's credit that margins held up pretty well this quarter. Gross margin eroded about 40 basis points sequentially, while operating income dropped 7% (and operating margin fell about a point). Companies like Altera (Nasdaq:ALTR) and Linear Technologies (Nasdaq:LLTC) have done better than ADI in past downturns largely because of a superior margin structure, but it looks like Analog has made some progress in this regard.

No Fast Rebound
Investors are not likely to be thrilled about the guidance from Analog Devices management. Their outlook for the next quarter calls for revenue to decline about 6% at worst and hold steady at best. That is not an especially encouraging forecast, but it is at least consistent with the expectations regarding Linear and Microchip (Nasdaq:MCHP).

The auto business seemed to be getting better in the quarter, and that's a little bit of good news for the analog sector, as companies like Analog, Linear, Freescale (NSYE:FSL) and Texas Instruments (NYSE:TXN) sell hundreds of millions of dollar of product to the likes of GM (NYSE:GM), Ford (NYSE:F), and Toyota (NYSE:TM). Still, if consumer confidence fades, so too likely will auto sales.

The bigger concerns are likely going to be in the industrial and communications segments. Throughout the second quarter, plenty of big-name tech companies made cautious comments about communications infrastructure demand and enterprise IT budgets. What's more, as industrial companies have started reporting that growth is going to get harder from here, they've been working down chip inventory and adjusting their orders accordingly.

How Should Investors Play This?
Analog Devices is a well-established company in the analog chip industry and has sizable share in markets like converter chips. Of course there is a threat of competition from the likes of Texas Instruments, ON Semiconductor (Nasdaq:ONNN), and so on, but Analog has design capabilities that are not easily supplanted. Moreover, the company has made progress in improving its margin structure. Of course, even that is not completely good news - protecting margins often comes at the cost of turning down business (as Linear Technologies investors have seen).

Right now there is probably more momentum in product cycle-driven stories like Broadcom (Nasdaq:BRCM), Altera, and Avago (Nasdaq:AVGO). The risk there, though, is much more downside exposure if the economy does trip over into another recession (and likewise, Texas Instruments and ON Semiconductor would seem to have more downside). In comparison, names like Maxim (Nasdaq:MXIM) and Linear have generally held up better during the downturns. Analog is something of a middle option - it lacks the dynamic growth potential of a story like Broadcom, but it should be in much better shape if the economy gets worse.

The Bottom Line
It certainly bares mention that Altera shows up on the list as both a good product story and a good full-cycle performer in the past. So Altera is certainly an alternative idea worth exploring. But turning back to Analog, this is a stock that seems undervalued on a full-cycle cash flow analysis as well as a conservative prospective cash flow analysis. Analog will not deliver the multi-baggers that fuel the dreams of aggressive growth investors, but when considering the risks and rewards and the uncertain economic outlook, Analog certainly seems like a chip stock that is appropriate for uncertain times. (To learn more, check out The Industry Handbook: The Semiconductor Industry.)

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