Taking Stock: Semiconductors: Rise Of The Stock Prices - InformationWeek
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William Schaff
William Schaff

Taking Stock: Semiconductors: Rise Of The Stock Prices

When semiconductor stocks drop, they tend to do so with a vengeance

What do the California recall election and the performance of semiconductor stocks have in common? Both have taken on an air of silliness lately. Here in California, we have 135 candidates running to replace Gov. Gray Davis. Arnold Schwarzenegger has declared that he will save the state from its current woes, and his rivals include former child star Gary Coleman. But the air of absurdity in California can't top what's going on in the stock market, especially when it comes to semiconductors.

Semiconductor stocks have performed marvelously this year as technology stocks have rebounded strongly. A common indicator of semiconductor stock performance is the Philadelphia Semiconductor Index, better known as SOX, which is up 47% as of Aug. 20. This is quite a bit better than the increase of almost 14% posted by the S&P 500 and even that of the Nasdaq 100, up about 32% for the year. However, SOX consists of only 17 stocks, including venerable names such as Intel, Micron, Motorola, and Texas Instruments, hardly making the index's performance indicative of the broader semiconductor industry. Looking at semiconductor stocks with market capitalization greater than $250 million, the picture is even better. The average stock in this group of 73 is up 71% since the beginning of the year.

There's no denying that the industry is in the nascent stages of a possible recovery. As has happened before, the performance of the stocks precedes that of the fundamentals. Revenue and earnings only now are starting to show signs of recovery, while the stock prices have already anticipated this. Research firm Gartner recently increased its forecast for growth in the semiconductor industry, and judging from the strong results reported in this quarter's earnings announcements, this is indeed the case. Semiconductor stock earnings are now expected to increase 31% in 2003 relative to '02 and 29% in '04 compared with '03.

As an investor, what I'm really interested in is whether these stocks are cheap or overpriced. Granted, valuation of semiconductor stocks is more art than science, given the cyclical nature of the industry. Examining our select group of 73 stocks, the average is trading at 36.5 times '03 analysts' estimates and 30.1 times '04 estimates. Compare this with the price/earning ratios on the S&P 500, which are 19.1 and 17.5 times '03 and '04 estimates, respectively. It isn't just the smaller stocks that are expensive. Intel, up 70% for the year, is trading at 38.4 times '03 earnings-per-share estimates and 29.4 times '04 earnings-per-share estimates--not exactly a bargain, in my opinion.

Once a semiconductor recovery gets into full swing, stock prices are likely to go higher than they should. Growth investors are probably the ones giving these stocks momentum, but watch out. When semiconductor stocks drop, they tend to do so with a vengeance, and all your gains might go hasta la vista, baby.

William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at bschaff@bayisle.com. This article is provided for information purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security. Bay Isle has no affiliation with, nor does it receive compensation from, any of the companies mentioned above. Bay Isle's current client portfolios may own publicly traded securities in one or more of these companies at any given time.

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