When the Chips Are Up, Investors Salivate

The (in)famously cyclical chip stocks are back in fashion. Also, more on the SEC and R&D write-offs.
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Chips are up. Now investors who got burned when semiconductors slipped in 1997 and 1998 because of overcapacity, weak demand and weaker pricing want to know if there's room to run for famously cyclical chip stocks.

To hear semiconductor pros wax eloquent about their sector, chips are just beginning to rock. Once investors are convinced of that, watch out. The first step is to check out the

coverage by

TSC's

Marcy Burstiner

of

BancBoston Robertson Stephens'

semiconductor conference last week in San Francisco. She explains that prices for memory-chip prices are firming, PC demand remains strong and equipment makers are reporting firm orders -- all strong signs for the overall industry.

Indeed, the mood was so buoyant that reports from conference attendees too shy to be quoted (i.e. their bosses won't let them talk on the record to the media) suggest that semiconductor companies see nothing but growth in the near term.

"Before they even took questions, the companies started talking about how good business is," says one chip investor.

Mark Edelstone, a semiconductor bull who didn't need to attend his competitor's conference to be exuberant about chip stocks, says there's no doubt that semis are firmly out of their down cycle. "Does the up cycle last two years or four?" asks Edelstone, of

Morgan Stanley Dean Witter

in San Francisco. "It's hard to say, but we're in the early innings."

Edelstone explains that all the characteristic signs of a full-blown chip recovery are evident. Semiconductor companies tend to stop adding manufacturing capacity when times get tough. That causes their inventories to become drawn down until pricing recovers. That time is now, he says, with order rates strengthening, lead times that customers must wait for deliveries lengthening and fewer chip companies disappointing Wall Street with poor profit reports.

"These are all the classic signs, and you'll see this intensify," says Edelstone.

He ticks off a longish list of favorites headed by communications-chip maker

Xilinx

(XLNX) - Get Report

, whose stock is up nearly fourfold in the last year, and

Microchip Technology

(MCHP) - Get Report

, a maker of chips embedded into prosaic applications like refrigerators or garage-door openers.

Daniel Niles, BancBoston's leading chip watcher, also favors a baseball analogy. "We're three innings into a general semiconductor industry recovery," he says.

(Memo to self: Ask venture capitalist John Doerr of

Kleiner Perkins Caufield & Byers

, famous for saying the Internet is still in the first or second inning of a long ballgame, what inning we're in at the moment.)

Niles injects a word of caution, however, suggesting that semiconductor stocks could pull back in August after a healthy run-up. Nevertheless, like Edelstone, he plugs Xilinx, a past Robertson Stephens investment banking client. He also like

Texas Instruments

(TXN) - Get Report

and

SanDisk

(SNDK)

, maker of movable "flash" memory storage that goes into digital cameras and MP3 Internet music players. Robertson Stephens helped underwrite a SanDisk stock offering in 1997.

Like Xilinx, shares of TI and SanDisk have soared. TI is worth more than three times its October valuation. Also in October, SanDisk traded for as little as 5 1/8. Hence the need by Edelstone and Niles to reassure investors there are more extra-base hits in store.

Though primarily a chip guy, Niles is perhaps best known for predicting the unexpected disappointment by

Dell

(DELL) - Get Report

in February. That call saved clients who heeded it a fall in Dell's stock from the mid-50s (adjusted for a subsequent split) to around 40.

Dell ended its fiscal second quarter last week, and Niles says his preliminary checks indicate the company will satisfy Wall Street's expectations when it reports earnings Aug. 17. "This is the first quarter in the last three that I haven't felt they've been struggling," he says.

Dell's stock price has been stuck around 40 since the disappointment and closed Friday at 40 7/8. That's as it ought to be, says Niles, considering the company no longer easily beats estimates as it had for years. A price-to-earnings ratio of 40 times profit guesstimates for the next fiscal year is plenty healthy for a company expected to grow earnings that year at about 35%, says Niles.

More on the FASB's 'Cave-In'

An important question arises regarding Friday's

column on the

Financial Accounting Standards Board's

postponement of the elimination of the write-off for acquired research and development: What happens to the companies that have been cajoled by the

Securities and Exchange Commission

to restate their merger write-offs over the R&D issue? That list includes important tech concerns like

Motorola

(MOT)

,

Network Associates

(NETA)

and

Cadence Design Systems

(CDN)

.

Short answer: nothing. Those companies and scores of others were reprimanded for misapplying the in-process R&D rules, at least in the eyes of the SEC. Simply put, they tried to expense business costs that -- in the SEC's determination -- weren't really research and therefore needed to be capitalized and written off over a longer period of time. The FASB's decision to postpone its axing of in-process R&D doesn't change a thing for the companies that were fingered earlier. The rules still apply.

"I see no indication that the SEC will quit reprimanding them," advises a spokeswoman for the FASB, the accounting profession's standards-setting body.

Adam Lashinsky's column appears Mondays, Wednesdays and Fridays. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. Lashinsky writes a monthly column for Fortune called the Wired Investor, and is a frequent commentator on public radio's Marketplace program. He welcomes your feedback at

alashinsky@thestreet.com.