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Chips ahoy!
Semiconductor stocks surged in May. Are there more good times ahead for the group?
May 27, 2005: 11:48 AM EDT
By Paul R. La Monica, CNN/Money senior writer
Surging semis: Is the May rally for the Philadelphia Semiconductor Index a sign of good times to come? Chip stocks have been extremely volatile.
Surging semis: Is the May rally for the Philadelphia Semiconductor Index a sign of good times to come? Chip stocks have been extremely volatile.

NEW YORK (CNN/Money) They say that April showers bring May flowers. But for semiconductor stocks this year, a more appropriate saying would be April dallies bring May rallies.

The Philadelphia Semiconductor Index or SOX, which tracks 20 leading chip and chip equipment firms, slumped nearly 8 percent in April but has surged 12 percent this month.

Shares of industry leader Intel (Research) are up 17 percent in May and have closed higher for the past 12 trading sessions. (That streak was in jeopardy Friday morning with Intel's stock slightly lower.)

Some smaller firms, including Broadcom (Research) and Marvell Technology Group (Research), have skyrocketed more than 20 percent.

So investors have to be wondering if this is just the beginning of more good times to come.

"There is a debate as to whether this is a relief rally or the start of a second half recovery," said Richard Whittington, an analyst with Caris & Co. "But the year has been bleak for the group and since we had such a big pullback early on, I think chip stocks have more upside."

Semi sentiment shifting

Heading into this year, there were some concerns about how strong demand would be for personal computers, cell phones and other electronic devices.

What's more, some investors were still worried about inventories -- a build-up in inventories last year weighed on semiconductor shares as investors feared that chip manufacturers would have to slash prices.

Bearish sentiment, as measured by the amount of shares that were being held by short sellers, was fairly high in the group earlier this year.

But strong first quarter results and robust second quarter guidance from the likes of Intel and leading cell phone chip maker Texas Instruments (Research) helped restore confidence. In addition, PC manufacturers Dell (Research) and Hewlett-Packard (Research) and cell phone makers Nokia (Research) and Motorola (Research) also reported healthy demand for their products.

As such, short interest declined in May, the first decrease in two months.

"I think this is the start of a sustainable rally," said Eric Ross, an analyst with ThinkEquity Partners. "Fundamentals appear to be good and end-market demand is good. Average selling prices for chips are holding up."

Chip-equipment firms have also bounced back sharply this month. Leader Applied Materials (Research) and smaller firms, such as Novellus Systems (Research), KLA-Tencor (Research) and Teradyne (Research) are all up more than 10 percent.

Patrick Ho, a chip-equipment analyst with Legg Mason, said the move is justified given the signs of stronger demand for PCs, cell phones and other devices.

"If nobody's buying PCs then nobody is buying chips and nobody is buying equipment," said Ho. "Having a healthier demand environment gives chip makers more confidence to migrate to leading edge equipment."

Is good news already priced in?

Given the big increase in shares, is it too late for investors to jump on board?

Ho doesn't think so but said that investors shouldn't wait too long. "These stocks had been beaten down so much so valuations are now attractive. But you have to get in early because people are starting to factor in a better second half and stronger 2006," he said.

Ross agrees that it's not too late to buy chip stocks. But he thinks that the group's performance could be choppy during the next few months so there could be some short-term trading opportunities. Still, he thinks the general trend is still for the sector to head higher in the long-term.

His top picks in the group are Intel, which he thinks will continue to benefit from strong sales of notebook computers, SanDisk (Research) and MIPS Technologies (Research). SanDisk makes flash memory storage cards used in MP3 players, digital cameras and other consumer electronics devices while MIPS is a supplier of processors used in digital televisions.

Whittington also likes Intel and adds that TI, Broadcom, Altera (Research), Xilinx (Research) and Analog Devices (Research) all still look attractive.

And Whittington said the key to the group's near-term success will lie in some upcoming mid-quarter updates from industry leaders. TI will issue its latest forecast for the second quarter on June 7 and Intel will follow suit on June 9. As long as both companies give rosy forecasts, he thinks chip stocks will keep rolling.

"I don't expect much of a pullback. There could be some pauses but if we get confirmation of strong demand from TI and Intel in the next few weeks, we could have a further sharp rally into July and beyond," he said.

For a look at more chip stocks, click here.

For tech commentary, click here.

Legg Mason's Ho owns shares of Applied Materials but his firm does not have investment banking relationships with AMAT or any other companies mentioned. Other analysts quoted in this piece do not own shares of companies mentioned and their firms have not done banking for them.  Top of page


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