On the Hunt for Bullish Chipmakers

 | Oct 31, 2012 | 12:08 PM EDT
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Finding a bullish stock chart in the semiconductor space these days is no easy task. Chipmakers are scrambling to find alternate revenue sources as demand for personal computers continues to wane. In recent months, cloudy fundamental outlooks have resulted in nasty selloffs in widely held chipmakers such as Intel (INTC), Texas Instruments (TXN) and Advanced Micro Devices (AMD).

While times are challenging for the chipmakers, a couple of fabless names are well-positioned for growth, including ARM Holdings (ARMH) -- a U.K.-based chip designer with a strong presence in the smartphone and tablet market. This company could care less about a weak PC market. ARM licenses its technology to scads of large-cap tech names, Apple (AAPL) among them.

Last week, CEO Warren A. East started off the company's third-quarter earnings conference call by saying, "Royalty revenues are at record levels, volume shipments are at record levels and licensing and backlog are at record levels."

Investors cheered the report after the company said earnings rose 29% from a year earlier to $0.18 a share. Sales growth accelerated sequentially, rising 24% to $233.5 million. Strong growth is expected to continue, as well, with full-year profit expected to rise 21% this year and 24% in 2013.

ARM continues to gain share in non-mobile markets, such as digital televisions and set-top boxes, as well as microcontrollers and smartcards. The company signed 29 licenses in the quarter for a very broad range of end applications, from embedded microcontrollers to image processors and digital cameras and mobile phones. About one-third of the licenses were brand-new, with many coming from Asia.

Even though major averages remain in a distribution phase, recent price and volume trends in ARM point toward a stock under accumulation. It's exactly the type of technical setup to target in the early stages of a new market uptrend. A look at its weekly chart shows the stock is in the early stages of breaking out from a long base.

ARM Holdings (ARMH) -- Weekly
Source: StockCharts.com

Technical support is strong in the $28 area. The only way the stock will get down to that level again is if major averages suffer another leg down, so the stock should be able to hold above that area for now. When the stock reaches its gap-up area on Oct. 23, it may or may not fill the gap. A common misperception is that stocks always fill gaps, but plenty of market precedent shows this is not always the case, especially when it comes to really strong stocks.

Keep in mind that major averages remain in technical downtrends until proven otherwise. It's tough for most stocks to make headway when the market tide is flowing negative. If major averages can follow through with conviction in coming days, a stock under accumulation like ARM, with its strong fundamentals and technicals, has a solid chance of outperforming.

Away from ARM, audio chip designer Cirrus Logic (CRUS) is a big supplier to Apple. However, I'm less keen on this name, which is scheduled to report earnings after the close Wednesday. The consensus estimate calls for profit of $0.71 a share, up 115% from a year earlier, with sales seen up 78% to $180.8 million. That would constitute solid growth, but I don't like the fact that Cirrus is heavily reliant on Apple for revenue. If growth starts to slow at Apple, which is a distinct possibility at this point, it won't be good news for Cirrus.

Frankly, both stocks look vulnerable to me. Shares of Apple have been under distribution for weeks now. Keep in mind that the stock has risen nearly 600% since the start of bull market in March 2009.

Cirrus isn't under distribution, but a look at its daily chart below shows the stock is starting to meet with resistance at its 50-day moving average. "Tired" stocks often show this type of price action, so there's a risk for more downside here.  The company should deliver strong numbers after the close, but will strong earnings be enough to lift the stock out of its doldrums? I don't think so. To me, the risk for more downside in Cirrus outweighs the potential for gains in the near-term.

Cirrus Logic (CRUS) -- Daily
Source: StockCharts.com

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