The Top Unsung Tech-Stock Leaders
Jon Markman
07/13/07 - 08:21 AM EDT
Summer is supposed to be the time of lounge chairs and beach balls for the stock market, but someone apparently forgot to tell technology investors.
For the first time in years, the world's largest computer companies are strutting across Wall Street with an undeniable swagger, as second-quarter earnings are likely to come in above expectations and shares are sweeping to multiyear highs.
It's not just
Apple's(AAPL) iPhone, either. It's notebook computers, set-top boxes, networking equipment, enterprise servers and high-definition televisions. It's operating systems, digital cameras and DVD players. It's RAM and flash memory.
Indeed, despite bears' forecasts that a plunge in residential real-estate values would scare off consumer and business spending, the demand for things that plug in, turn on and help you tune out is as strong as ever.
Have you taken a glance at the
Nasdaq Composite lately? It was only a couple of months ago that the strength of the
Dow Jones Industrials was all anyone wanted to talk about. But suddenly, and rather quietly, here in July the Nasdaq has slipped into the lead among the major indices for the year, the recent stumble notwithstanding. It has clocked a rather stunning 10% return so far in 2007, compared with 7% for the
S&P 500.
Unsung Stock Heroes
"Stunning" seems like the right word, because the Nasdaq hasn't busted a move like this for three long years. In 2006, the tech-heavy index peaked briefly with a 10% gain for the year in November but then slacked off and ended the year up only 8%. In 2005, it peaked at 5% in November and ended the year up 2%. In 2004, it peaked at 7% at the end of the year. So a 10% advance in six months should definitely get your attention.
Much of the strength of the Nasdaq can be laid to the surges at Apple, BlackBerry maker
Research In Motion(RIMM), Internet retailer
Amazon.com(AMZN) and alternative-energy providers
First Solar(FSLR) and
SunPower(SPWR), which have seen shares rise 50% to 200% this year.
But there are a whole bunch of unsung heroes in the Nasdaq that deserve your attention as well, as they could provide a lot more fireworks this summer and into the rest of the year.
The semiconductor sector should be right at the top of your list, headed by the newly invincible
Intel(INTC). Skeptics and rivals have tried to kick this company down the stairs, but it keeps coming back. It's already up 24% this year and could easily advance another 30%-plus if its valuation were to catch up with its undeniable earnings growth.
The key driver for Intel, I believe, will be a surprisingly fast ramp-up in the second half of the year to support
Microsoft's(MSFT) much-maligned Windows Vista operating system.
A Cowen & Co. study found that two-thirds of large businesses and three-quarters of small businesses plan to make the switch to Vista over the next 12 months after Microsoft publishes its first Service Pack, a collection of patches and enhancements that fix a bunch of bugs found in the software's initial release. Most plan to implement Vista via new computers, not by upgrading existing machines -- leading to a surge in demand for the Intel chips that serve as their brains.
Cost Savings Inside
Intel is very well positioned for this change in the demand cycle, as its larger and more advanced factories will give it a leg up on arch-enemy
Advanced Micro Devices(AMD). Intel operates four microprocessor foundries, or "fabs," in the U.S. and Ireland. Two new fabs are scheduled to open in the next couple of years, including one in Israel, which will be able to manufacture processors with a more efficient process than the one currently used.
So by the end of 2008, Intel will operate six fabs in all, four of which will operate on the advanced 45-nanometer process. Analysts expect this to slash production costs by a fifth, pushing gross margins much higher to nearly 60%, up from the current 52%.
With this expanded, low-cost production base, Intel will be able to competitively cater to users in developing nations, which already make up 40% of annual sales. In fast-growing nations such as Brazil and Russia, there are only about 10 computers per 100 members of the population, according to a United Nations study, compared with 76 per 100 Americans.
More reasons for optimism? Well, credible rumors are making the rounds that Intel's next-generation chip set, called Penryn, might be introduced in computer servers as soon as October -- two months ahead of schedule. That would put it in place to beat Advanced Micro's new server product, Barcelona.
For these reasons, I believe Intel's recent performance in the market is only a taste of what is to come. Right now, the stock is trading at 18 times my 2008 estimate of $1.40, which is at the bottom of its historic range. If the market gives the stock a more typical 25 times multiple and if investors come to believe that earnings estimate is achievable, you'll see shares at $35 to $38 by the end of 2008, which would be up to 50% higher from here. OK, now I'll say it: It's time to get Intel inside your portfolio.
Profit in Gadgets
If you want to consider a smaller chipmaker instead, take a look at
Zoran(ZRAN), which trades for $20 and sports a $1 billion market cap. It is probably the strongest up-and-comer, as it sells "systems on a chip" products into some of the fastest-growing segments of technology, including digital television, digital still cameras, high-end camera-phones and the new generation of high-definition DVD players.
Its customer list includes all the top manufacturers -- Sony,
Eastman Kodak(EK), Nikon, Samsung, LG Electronics,
Royal Philips(PHG), Toshiba,
Lexmark International(LXK), Ricoh and Konica Minolta -- which are all looking to lower costs and improve imaging quality with its proprietary designs. In other words, while Intel is focused on businesses and PCs, Zoran gives you exposure to consumer electronics.
Just to focus on one market for a moment, note that industry analysts believe the market for the semiconductors that go into digital television set-top boxes will grow to $7.7 billion in 2010, from $4.7 billion today, an 18% compound annual growth rate. Meanwhile, the chips that go into flat-screen TVs will grow to $6.9 billion in 2010 from $3.5 billion today, a 25% annual growth rate.
Chipmakers leveraged to fast-growing segments like this will find success even if the overall market for technology stalls. I estimate that Zoran -- whose technology team largely hails from Israel but is based in Silicon Valley -- will earn as much as $1.26 per share in 2008 and deserve a price-to-earnings ratio
of 25. That would put the stock at $31 next year, amounting to a 55% move. Tune in.
