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Chip-Equipment Cycle Confounds

The sector has lagged behind other tech stocks this year as uncertainty has proven the rule.

SAN FRANCISCO -- With uncertainty comes underperformance.

And both terms apply this year to semiconductor-equipment stocks, which have lost ground to other tech stocks in 2005, because of the mystery of where the industry sits in its current business cycle, according to six analysts who gathered here Thursday for a panel discussion.

While some clarity is expected shortly as earnings season gets under way, even that might not be good enough to clear up the confusion about where stocks go from here. Half the panel's analysts predicted that a peak in stocks will occur at the start of 2006, while the other half predicted a trough will occur at the same point.

These bifurcated opinions come on the back of a rally that began two weeks ago and lifted many chip-equipment stocks, such as

Applied Materials

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Novellus Systems



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, back to break-even for the year.

Not that the varied opinions were a total shock -- after all, the title of the discussion was "Bulls and Bears" -- but they do illustrate the difficulty in making money in this volatile sector.

The panel discussion, held as part of Semicon West, the chip-equipment industry's largest trade show, was actually more of a debate featuring alternating viewpoints about the industry's growth rate (both past and present, oddly enough), the importance of cash flow as an indicator of stock appreciation, as well as the importance of consolidation as a creator of investor wealth.

The bulls' belief is that chip-equipment order rates will turn higher in the third or fourth quarter (a delay from projections earlier this year of a second-quarter turn) and this will spark stocks. The run-up would last through the beginning of next year, and then cease once actual orders materialized (since investors anticipate turns in fundamentals).

Analyst Tim Arcuri of Smith Barney Citigroup cited improved business models, a more responsive equipment industry and increasing factory utilization as reasons why tool orders will soon be increasing.

But the bears saw no imminent upturn in orders, as major memory manufacturers continue to hold off on expansions. This, in turn, should result in reduced industry estimates for 2006, which would then drive down stocks.

Analyst Mark FitzGerald of Banc of America Securities says the bubble mentality is still pervasive in this industry, despite growth rates that are closer to the broad economy. "We are still bearish on the idea that these are high-growth stocks and that you can slap a high multiple on them," he says.

The truth in investing is that nobody can really spot a bottom or top until it has passed. It's true for the broad market and it's especially true for the semiconductor-equipment industry. If it wasn't, everyone would make money.

So, where does this leave investors faced with a mix of opinions from the "experts"? In this sector, they're where they've always been -- on their own.