Investing in Tech Stocks With Strong Growth Potential

By: Uncommon_Wisdom

Rudy Martin writes: After I saw investors dump tech stocks like hot potatoes — after tech-bellwether Cisco (CSCO) recently reported dismal quarterly results — I kept wondering where the values might be for longer-term investors.

How might you avoid the Cisco fallout from slower U.S. and European sales? What if you could select companies with more than 20% of revenues coming from emerging markets such as China?

One way is to take a closer look at the other stocks in the Philadelphia Semiconductor Index. It’s up 15.6% over the last 52 weeks, down from a high of 400 in April but outperforming the average U.S. stock during that time.

Source: Bloomberg

This index contains 30 stocks, many of them based abroad, and several directly benefiting from doing business in emerging economies.

Consider this:

• Semiconductor bookings dropped rapidly in Q408 with demand remaining weak in first half of 2009.
• The impact on the industry’s revenues was greater than most analysts had initially expected.
• Industry utilization rates reached unprecedented low levels, and production capacity was cut to react to lack of demand for chips.
• Inventory levels were substantially reduced pushing the pain down the supply chain.

Some Markets Are Recovering Faster Than Others

But the impact of the 2008-2009 economic downturn has varied by geography. China, for example, started to recover in 2009. In contrast, Europe, the United States and Japan continue to experience difficult conditions.

We’ve seen the traditional markets of North America, Western Europe and Japan somewhat improve relative to the low point that they struck, but those markets are on a path that may take a number of years to recover to their previous high points. Meanwhile, the global market bottomed in mid-2009.

What has changed is demand in the emerging markets. I think it’s unfair to call China an emerging market anymore as it is the largest car market, the largest energy consumer, has come through this crisis and shows no signs of really declining without an external break.

It’s no wonder the Chinese government is trying to control the growth and conserve resources through various measures such as shutting down inefficient energy plants and reducing exports of scarce resources.

The recovery in these semiconductor names has been uneven. The worst-performing stocks of the last year have been the traditional semiconductor leaders. Companies such as Intel Corp (Nasdaq:INTC) up only 4% and National Semiconductor (NYSE:NSM) is down 9%.

The clear winners were specialty-focused Cirrus Logic (Nasdaq: CRUS) up 143%, SanDisk Corp (NasdaqGS:SNDK) up 77% and Avago Technologies (NasdaqGS:AVGO) up 54% during the last year.

The two fundamentals that have driven the growth of the winning tech stocks are (1) more cars and (2) more content. And with a clear play in China they should see a very strong demand upsurge in the near term and into 2011.

Here are two tech picks that could ride that strong demand upsurge:

Tech Pick No. 1

This company is a smaller stock at about $1 billion market value with a great franchise and even better financials. It’s focused on smartphones, the fastest-growing segment in the cell phone and portable media market.

Cirrus Logic, Inc. (Nasdaq:CRUS) develops high-precision, analog and mixed-signal integrated circuits for a broad range of uses like smartphones, portable media and the energy industry.

The company generates 70% of total revenues from audio and the rest from energy-related applications. It’s Tier-1 customers include Bose, Harman (NYSE:HAR), Ford (NYSE:F) and Sirius XM (NasdaqGS:SIRI).

Last quarter revenues grew more than 81%, with strong margins of 56% and increasing earnings. It’s able to keep costs down by using a variety of foundries, assembly and test partners.

Financially, the company has $182 million in cash with no debt. Its stock is so cheap that the company just completed a $20 million share repurchase and announced another $80 million.

Obviously, this was the stock to buy 12 months ago. CRUS is up 142% in the past 12 months.

The uncommon wisdom here is this semiconductor stock, with a unique niche and high financial flexibility, has a very bright future in the next 12 months.

Tech Pick No. 2

My next pick is a stock that will benefit even more from the electrification of the automobile. Hybrid and fully electric cars could make up 10% of the entire production of automobiles in 2020.

STMicroelectronics N.V. (NYSE:STM) is a Swiss-based firm that designs, develops, manufactures, and markets semiconductor integrated circuits and discrete devices. The Company’s products are used in the telecommunications, consumer electronics, automotive, computer, and industrial sectors. Geographically, 60% of its customers are located in Asia, 27% from Europe and 13% from the Americas with total revenues last year of more than $8.5 billion.

It’s the fifth-largest semiconductor company in the world and the leader in Europe. It has key alliances with Bosch, Ericsson, Hewlett Packard, IBM, Nokia and Samsung.

If you look at the cash flows on this one, you’ll see that it’s been generating $2 billion to $2.5 billion in cash from operations in the 2006-2008 period. It will surely post better numbers at yearend 2010 than it did last year. It’s trading at 4.9 times enterprise value to next year’s cash flow — only 73% of the peer average.

Why the discount? In five of the last seven reporting periods, it posted losses. Fortunately, profits have swung positively by $1.2 billion dollars in the last 18 months. When it reports in mid-January, I expect this one to have well over $3.5 billion in cash on the balance sheet and a higher valuation.

Let me close with this: Technology stocks historically show greater volatility than the average industrial stock. While you can lose money in any stock, these two companies have solid franchises, great financial flexibility and still sell cheaply relative to their recovery-based growth.

Best wishes and happy trading,

Rudy

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