I've made no secret in the past of my respect for Linear Technology (Nasdaq:LLTC). This specialist in high-performance analog (HPA) chips is not only one of the largest analog chip companies; it boasts some of the strongest margins and long-term returns on capital in the industry.

Although I believe the company is in a good position to meet growing demand in the industrial and automotive categories, I'm less confident that its business philosophy makes it a great pick for a chip rebound.

SEE: Business Plan: Your Organizational And Operating Plan

Does this Quarter Mark the Bottom?
Linear had a decent enough fiscal second quarter, with revenue up 3.7% from last year and down about 9% sequentially. Although that was a little short of analyst expectations, it was a modest miss at worst. Computing continues to be quite weak, and the recovery in communications has been sluggish at best. Industrial was weak late in 2012 (no surprise given the fiscal cliff drama), but autos looked a little stronger.

On the profit side, Linear lost a little leverage. Gross margin fell about half a point from last year and a similar amount on a sequential basis due in part to mix and pricing. Operating income was likewise sluggish - down slightly from last year and down 14% from the prior quarter. At 43.5%, Linear's operating margin was more than a point shy of analyst expectations.

SEE: A Primer On Investing In The Tech Industry

The Markets Aren't Exactly Roaring Back
Listening to management's comments on the call, it sounds like the first two months of this quarter were pretty weak from an orders perspective, with orders improving significantly at the close of calendar year 2012. Even so, management guided to sequential revenue growth of 1-4%, with the mid-point about a point below the prior analyst expectation of 3.5% growth.

Investors should not expect a red-hot recovery from Linear. Almost two-thirds of the company's business comes from industrial and automotive customers, and while those industries may end up with a better 2013 than feared just a month ago, investors have heard a lot of cautious guidance recently. In particular, companies such as Agilent (NYSE:A) and Siemens (NYSE:SI) have been a little cautious on test/measurement and factory automation - big end markets for Linear's industrial chip business.

It's also important to note that Linear's exposure to handsets and mobile devices is very low - just rounding errors compared to companies like Broadcom (Nasdaq:BRCM) and Avago (Nasdaq:AVGO). Consequently, ongoing strength in that market won't help Linear all that much.

SEE: 4 Basic Elements Of Stock Value

Good Business, but Maybe not the Right Time
There's a lot to like about Linear. The company's IP position is strong, and it has long been a leader in the HPA market. What's more, the acquisition of Dust Networks last year could be a big deal down the road if companies adopt wireless sensor networks in a big way.

On the other hand, Linear manages itself a little different from others. The company is fierce in protecting its margins, and it will turn away growth if it comes at too high a cost to its margin goals. Witness the fact that the company basically let itself get designed out of the Apple (Nasdaq:AAPL) iPad as opposed to taking a lower price. Consequently, I think Linear generally works better as a chip stock to own during tougher times in the chip sector, and not so much during rebounds or growth cycles.

The Bottom Line
Plenty of attractively-priced chip stocks are still out there, including Broadcom and Avago. For Linear, however, I see less near-term potential. On the basis of mid-single digit long-term revenue and free cash flow growth, I believe these shares should trade in the mid-$30 range, more or less in line with the current price. While this chip stock probably has limited downside, I don't think the upside is particularly compelling right now.

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

Related Articles
  1. Economics

    The 9 Industries Driving Texas' Economy

    Find out which industries are driving the Texas economy. Learn about the largest and fastest growing employers and producers in Texas.
  2. Stock Analysis

    The Biggest Risks of Investing in Facebook Stock

    Find out what risks Facebook shareholders face in coming years, and why the social media giant may struggle to find new markets in the future.
  3. Stock Analysis

    The Biggest Risks of Investing in Apple Stock

    Read about the biggest risks facing Apple, Inc., and why AAPL investors should always be prepared for the day when the tech giant starts to struggle.
  4. Stock Analysis

    Will WYNN Continue to Rally?

    Wynn Resorts has experienced a rally recently. Will it remain a good bet?
  5. Stock Analysis

    Don't Be Fooled by the Market's Recent Rally

    The bulls won for a bit in early October, but will bears have the last laugh?
  6. Stock Analysis

    Will Twitter's Stock Find its Wings Soon?

    Twitter is an enigma to many investors, but its story is pretty straightforward.
  7. Investing Basics

    How to Think About Seasonality Trends

    Investors benefit when company research incorporates seasonality trends that predict relative strength and weakness throughout the calendar year.
  8. Stock Analysis

    8 Solid Utility Stocks for a Bear Market

    If you're seeking modest appreciation, generous dividend payments and resiliency, consider these eight utility stocks.
  9. Stock Analysis

    Why Phillips 66 (PSX) is a Solid Long-Term Bet

    Here's why Phillips 66 will likely remain one of the world’s largest and most profitable companies for a long time to come.
  10. Investing

    This New Trend Makes Robotics an Industry to Watch

    Robots created to work with humans, instead of taking their place, have the possibility to change the face of manufacturing across the globe.
  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 >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!