CHICAGO, Sept. 19, 2011 /PRNewswire/ -- Stocks featured in this week's Zacks Industry Rank analysis include Applied Materials (Nasdaq: AMAT) and Intel (Nasdaq: INTC).
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Zacks Industry Rank Analysis is written by Dirk Van Dijk, CFA, Chief Equity Strategist, Zacks.com.
Out of Chips
Arguably, the single-most-important invention of the 20th century was the semiconductor. Semiconductors are as central to the modern economy as steel was in the heyday of Carnegie, Frick and Krupp. They are the basic "raw material" of the tech world.
Thus when we see the semiconductor industry displaying significant weakness or strength, the implications can go far beyond just the companies that make the semiconductors or the equipment needed to produce them. They are basic building blocks, not just for computers and communications equipment, but into just about every manufactured product.
Every car produced today, for example, has more computing power on board today than the Apollo 11 spacecraft did. That computing power is embedded in the semiconductors the car uses.
Semis Slipping
Some of these "industries" are extremely small, two of the ten have only a single firm in the industry, and two more have only two firms in them. The others range from having four firms in them up to 18 members. There are a total of 70 firms in these ten industries combined.
Of those, 16 (22.9%) of them hold the dreaded Zacks #5 Rank, and an additional 20 (18.6%) have Zacks #4 Ranks. If the Zacks ranks were random, then one would expect that 5% of the names in an industry would be #1's and 15% would be #2's.
Most of the firms are either small (below $1 billion) or mid-cap firms (between $1 billion and $5 billion). Only one, Applied Materials (Nasdaq: AMAT) is a bona fide large cap with a market cap of over $15 billion.
It and the mid-caps most likely have options that could be used to bet against the firms, and they probably have enough liquidity that you could, if so inclined, short them. As for the small caps, sell them if they happen to be in your portfolio, but if not, it is probably best to just ignore them altogether.
A Smorgasbord of Valuations
The valuations on these firms are all over the lot, ranging from seemingly cheap mid-single-digit levels based on 2012 earnings, to those where the P/E cannot be calculated because the firms are expected to lose money. Notice, however, that the expectations are dropping like a rock. An estimate in motion tends to stay in motion.
Thus it is very likely that the estimates will continue to fall, and that the true earnings will turn out to be much lower than the current estimates anticipate. Thus the "true" P/E based on both 2011 and 2012 earnings will be much higher than shown here.
If you do feel the need to have a chip stock in your portfolio, stick to the larger-cap firms that offer solid balance sheets and good yield support that still have Zacks #3 Ranks or better. The 800 lb gorilla of the industry, Intel (Nasdaq: INTC), fits that description nicely.
This is no time to be a hero buying beaten down small caps with deteriorating earnings prospects. Low P/E's based on earnings that are falling apart are the thing that value traps are made of.
Given that the chips are at the base of the tech food chain, it would also make sense to be cautious on other tech firms, particularly on the hardware side. I would note that several other industries that provide components (i.e. miscellaneous components, connectors, fiber optics and solar, which shares lots of technology with chips) to the tech sector are also showing weakness on the Zacks Rank as well.
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