Is the chip industry headed for a repeat of the 2004 bust?

That seems to be the sentiment among some investors, judging by last week's reaction to a pair of closely watched semiconductor companies' financial reports.

Texas Instruments ( TXN) and National Semiconductor ( NSM) both delivered upbeat financial numbers, only to see their shares tumble. TI shares fell more than 3% the day after its results, while National's shares shed 90 cents, about 4%, in the wake of its report.

The common thread among both chipmakers was inventory, which each firm acknowledged was increasing -- something that has a tendency to spook investors.

"The spreading shift from inventory depletion to building supply (INTC, TXN, etc.) adds to our concerns regarding an approaching cyclical peak," wrote Deutsche Bank analyst Ross Seymore in a recent note maintaining a hold rating on National Semiconductor. (According to Deutsche Bank the research analysts who prepared the note, or their family members, own shares of National Semiconductor.)

But while inventory levels deserve careful monitoring, they don't warrant recent fears of an impending chip-sector slowdown, say some analysts and investors -- at least not at this stage.

"Every time inventories build, people in general get very nervous," says Piper Jaffray analyst Tore Svanberg. "You get a little bit of panicking, especially when things have been as good as they have in the semiconductor sector."

Svanberg believes these fears are overblown, noting that inventory throughout the supply chain is always up during the March quarter. (National Semiconductor has been an investment-banking client of Piper Jaffray's during the past 12 months.)

In some sense, the chipmakers have been victims of their own success. The fact that sales in the seasonally slow first quarter are not down as much usual has raised fears that customers are buying more chips than they actually need. The danger is that customers will ultimately be forced to sharply curtail their orders, as they work to sell off the inventory they've accrued.

That's what happened two years ago, when the semiconductor industry suffered its most recent downturn. The buildup in distributor inventory caused revenue at TI, National Semiconductor, Philips Electronics ( PHG) and other chip companies to fall below their targets. TI slowed down production at its manufacturing plants, while Agere Systems ( AGR) laid off 500 workers.

National Semiconductor President Don Macleod says those were different times.

"The root cause wasn't the inventory in 2004, it was that the demand in the market fell below expectations, and inventories built up for that reason," says Macleod. Today however, National does not see any dampening of demand.

In fact, Macleod says distributors have experienced better-than-expected demand and sell-through in the first part of the year, and that, combined with the upcoming period of stronger sales, is causing distributors to boost orders.

In its recently completed quarter, National Semiconductor said its distributor inventory slightly surpassed the 10-week level, while it was slightly below the 10-week level in the previous quarter. But Macleod says inventory levels could stand to rise even another week in the current environment, and that they were far below the levels they were at during the 2004 bubble.

TI also believes that inventory levels could be higher. The company has taken steps to boost inventory levels after its chip output was limited by a lack of assembly and testing equipment in the past two quarters.

This production bottleneck, coupled with the growth in the wireless market, makes TI's inventory approach justifiable, says American Technology Research analyst Satya Chillara.

"I don't see any major red flags," says Chillara, whose firm does not own shares or have business relationships with TI.

With the Philadelphia Stock Exchange Semiconductor Sector Index down 8% from its most recent peak, however, not everyone is as confident in the chip industry's prospects.

Bob Bacarella, portfolio manager of the Monetta Fund, traces the recent selloffs to hedge funds, which he says are paid to move quickly and react instantaneously to information.

"That's what creates the volatility," says Bacarella, whose firm owns shares of both TI and National Semiconductor.

While he doesn't discount the possibility of a future inventory correction, Bacarella says it's still much too early to make that call.

"You've got to look for a more defined trend. And the trend isn't defined by one month. It's a three-, four- or five-month period," he says.

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