(Note: The author of this fundamental analysis is a financial writer and portfolio manager.)
Chip stocks have been one of the hottest groups in 2017 and will probably continue to rise. The group's growth can be attributed to strong earnings growth and valuations that are cheap when compared to the overall market.
Shares of Broadcom, Qualcomm, and Intel Corp. (INTC) are currently trading at one-year forward earnings estimate multiples that are less than 17 times. That's lower than the S&P 500's multiple of 19 times.
At a multiple of 19 times one-year forward earnings estimates, Intel stock would be valued 40 percent higher at $62, while Broadcom could be worth almost 26 percent higher, or nearly $340. (See also: Broadcom Price Targets Hiked After Brocade Deal.)
Should Broadcom be able to close the deal with Qualcomm, one could argue that Broadcom stock could trade at an even higher premium. Cost-saving synergy would likely unlock additional earnings growth.
Broadcom could also choose to drop the lawsuit Qualcomm has against Apple, easing some of the uncertainty around the future of Qualcomm's future revenue stream. (See more: Qualcomm's Feud With Apple Now Ropes in Intel.)
Boom and Bust Cycles
Chip stocks have historically traded at a discount valuation to the market due to the cyclical nature of the business and because of the companies' dependence on sales from the wireless phone industry, such as the iPhone cycles.
But it may be time to rethink that reasoning as technology, and more importantly, chips become even more integrated into our daily lives. One industry that is going through tremendous change is the auto industry, which is likely to see increasing amounts of chips as autonomous driving continues to develop. That could fuel further growth for chip makers like Intel and Broadcom.
Not All Cheap
But not all stocks in the sector are cheap. Nvidia Corp. (NVDA) is an example of a stock that trades at an expensive valuation, nearly 38 times one-year forward earnings estimates.
If chip makers like Intel and Broadcom can generate earnings and revenue growth rates that are more predictable and less of a boom-and-bust cycle, companies like Intel and Broadcom could demand a higher valuation. Should growth rates continue to rise at rates higher than those of the market, then perhaps they deserve premium valuations.
Michael Kramer is the Founder of Mott Capital Management LLC, a registered investment adviser, and the manager of the company's actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of three to five years. Click here for Kramer's bio and his portfolio's holdings. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future performance.