Chips Riding the Wave

 | Sep 16, 2011 | 2:30 PM EDT
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Broadcom (BRCM) announced Monday that it planned to acquire NetLogic (NETL), and the news sent chip-sector stocks soaring as investors renewed hopes of an improved business climate as well as more deal potential.

The chip rally was simultaneous with four days of upside trade in the broader markets, which were largely spurred by optimism that European governments were dealing with Greece's debt situation. Nonetheless, the chip rally is notable because several stocks in the sector climbed on heavier volume -- a sign that institutions are piling into the stocks.

Price, naturally, is the first indicator that investors notice, regardless of whether they're chartists. However, volume shouldn't be overlooked.

As of Thursday's close, Taiwan-based Silicon Motion Technology (SIMO) bolted more than 21% for the week in more than double the average trade. Early Friday, it cleared a four-month price consolidation.

It's often the smaller stocks that notch explosive price moves. Silicon Motion fits that mold, with market capitalization of just $405 million, and 438,000 shares traded per day. Of course, thinner trade means a stock can fall sharply in a market correction. Between mid-May and mid-August, Silicon Motion dropped 38%. The stock tends to display wider intraweek price swings than do more liquid issues.

On a fundamental basis, the picture looks bright. The company turned profitable again in 2010 after a loss of $0.37 per share in 2009. This year, earnings are expected to come in at $0.96 per share, more than double last year's $0.44. It's also significant that sales have bounced back, which means the earnings growth is driven by demand, and not by cost cuts. As for 2012, an earnings increase of another 21% is expected for the year.

Another chip-sector name that's climbed in better volume is fellow Asia-based chip designer Avago (AVGO). The company's analog semiconductors are used in a range of voice and data gear in various industrial applications.

Friday morning, Avago shares had advanced 13.4% for the week in heavier volume. The prior week had only four trading sessions, but a drill-down to daily volume on Avago shows above-average upside trade during a couple of sessions in the week. That means institutional investors were indeed getting behind the stock.

Avago, while a possible watch list candidate, lags Silicon Motion in some respects. The pace of profit and sales growth has slowed in recent quarters, and Wall Street sees earnings growing 23% this year, but just 9% in 2012.

However, there are some positive factors that investors should not overlook. The stock went public in August 2009, and is still likely undergoing its youthful growth spurt. It also boasts good liquidity, trading more than 2 million shares a day. Its market cap is nearly $9 million.

The chart shows a stock attempting to work its way back to its previous high. It's currently trading about 8% below its early July peak of $39.45. Watch for continued heavy volume as it approaches that price again.

Another overseas-based designer of semiconductor technology is Israel's Mellanox (MLNX) -- another stock that showed fast trading this week as it rallied to new highs. Mellanox is a small-cap name that's prone to some volatile trade. Its beta is on the high side, at 1.46, an indication of how it trades relative to the broader market. The company's market cap is $1.2 billion, and it trades about 323,000 shares a day.

On a technical level, Mellanox has been a solid performer, but the fundamentals have been less than stellar. The company has remained profitable, though the pace of earnings declined in the past four quarters. Still, sales growth has remained robust, coming in with increases of 52% and 59% in the past two quarters.

However, analysts see a return to better levels of profitability in 2012, with expected earnings of $1.58 per share. That would mark growth of 42% over 2011's expected income of $1.11 per share.

Though there are several chip-sector names notching strong gains, I'm still partial to companies such as Silicon Motion, which sport the solid combination of fundamental and technical strength. Avago and Mellanox show strong technicals, and they could be good shorter-term trades, but the fundamentals remain something of a question mark for now.

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