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Highflying Semiconductor Stocks Have More Room to Fly, Says Analyst

A key red flag, equipment spending, hasn't been raised. Still, it's late in the game to catch more upside.

SAN FRANCISCO -- While some people are worrying about a top in technology stocks, particularly the very cyclical semiconductor stocks, Robertson Stephens analyst Sue Billat isn't one of them.

Billat watches the semiconductor-equipment sector, which is an early indicator of the health of the chip market and technology in general. Just about any technological device has a chip in it, so if a tech company expects to sell lots of product, it needs lots of chips. The chipmakers can't meet that demand without first upgrading their manufacturing and testing equipment.

Some tech investors might be getting vertigo from the heights some of these stocks have reached. Chip-equipment leader

Applied Materials

(AMAT) - Get Applied Materials Inc. Report

has risen more than 140% over the last six months, and about 670% since the market turned in October 1998. The fear comes from the inevitable downturn. The last time the market turned south, in August 1997, AMAT lost 60% of its value over the next 12 months.

It's not time yet to bail, says Billat, who has watched the sector for 20-some years. "Everything is fabulous," she says. The red flag she's watching for is equipment spending. When chipmakers spend too much, it means there soon will be too much manufacturing capacity.

That means chip prices will come down, and profits will sink. Historically, chipmakers spend 26% of their annual revenues on new equipment. They haven't reached that level this year, and she won't worry until they reach 30%. That likely won't happen, according to


, until next year or the year after.

It's late in the game to get into this lucrative area now, but there still are a few companies with room left in their stocks. That's because there are different kinds of equipment, and some aren't bought in large volumes until later in the chip cycle.

The best example is


(PLAB) - Get Photronics Inc. Report

, a maker of photomasks -- filters that transfer patterns onto a chip. While AMAT started falling in August 1997, Photronics didn't start its downturn until April 1998 -- but then it fell more than 65% over the next four months.

But even Photronics -- not an underwiting client of Robertson Stephens -- has risen considerably. Which brings us to another question: What about the equipment makers whose stocks haven't shown much growth at all so far? This has been a great market for the sector, Billat says, and if that isn't reflected in the stock price yet, better keep your hands off.

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High Dives

If you don't believe that investors are jittery these days, just take a look at


(CNXT) - Get VanEck Vectors ChinaAMC SME-ChiNext ETF Report

, a communications-chip leader, which until Feb. 24 was a highflier. Over the past five days, though, the stock has plunged 35% to close at 78 15/16, even as the

Philadelphia Semiconductor Index

gained 7%. In part, investors were spooked by a Feb. 28 downgrade by

SG Cowen

analyst Rick Billy from strong buy to buy.

Merrill Lynch

analyst Joseph Osha points out that until Feb. 24, Conexant had been on a tear, rising more than 120% since Jan. 6. In this market, he says, when stocks move up that steeply, people will panic on the first tidbit of bad news. In Conexant's case, he says, they are panicking for little reason.

The only negative news out of the company is one of slowing sales of products for remote-access equipment because of competition from

Analog Devices

(ADI) - Get Analog Devices Inc. Report

. But that business is just about 5% of sales, he says. Neither Merrill Lynch nor SG Cowen is an underwriter of Conexant or Analog Devices.

Only if you worry about the communications sector in general should you worry now about Conexant, which is one of the most broadly diversified companies in that hot sector.

Scott Vergin, portfolio manager for

Lutheran Brotherhood Management

, which manages $2 billion in mutual funds and insurance assets, believes the stock is oversold. "I'm always concerned when a stock takes that big of a dip, and it has been hammered," he says. "But I think a lot of the air has been let out of it." He says he's considering buying more.