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  1. Home
  2. / Investing
  3. / Technology

Chip Stocks Have a More Compelling Risk/Reward After Their Recent Tumble

Chip equipment and memory stock particularly look more attractive now.
By ERIC JHONSA
Feb 29, 2020 | 08:00 AM EST
Stocks quotes in this article: SOXX, AAPL, TSM, AMAT, LRCX, KLAC, MU, WDC

Chip stocks definitely aren't immune to the business fallout caused by the coronavirus outbreak. But after a week of heavy selling, many of them are once more trading at pretty moderate valuations.

Though it finished up 2.2% on a wild Friday for U.S. equities, The Philadelphia Semiconductor Index (SOXX)  is still down 14% from its Feb. 19 peak. And quite a few names are down more than 20% from their 52-week highs.

With the coronavirus outbreak having done considerable near-term damage to both Chinese manufacturing activity and end-user demand, and with South Korea (home to Samsung, LG and SK Hynix, among others) now also reporting a sizeable number of cases, there are plenty of reasons to think that the next couple of months could be rough for chip developers, as well as the foundries and test/assembly firms relying on them.

However, there are signs that manufacturing activity is improving a bit in China, even if it's still far from normal. For his part, Tim Cook said on Thursday that the factories of Apple's (AAPL) Chinese contract manufacturers are getting closer to normal production, after being shut down earlier in the month.

And though it might feel like a distant memory right now, this last earnings season was a pretty strong one for chip companies. Many chip developers, foundries and test/assembly firms reported demand is on the upswing following 2019's inventory corrections, and chip equipment makers generally delivered upbeat outlooks amid strong orders from Intel and Taiwan Semiconductor (TSM) .

Equipment makers such as Applied Materials (AMAT) , Lam Research (LRCX) and KLA (KLAC) (just to name a few of the bigger ones) have been slammed during the selloff, with many of them once again trading for 12 to 15 times forward EPS. And compared with chip developers, equipment makers might see less of a top-line hit from the coronavirus outbreak, should chip manufacturers whose sales have been affected by the outbreak wager that demand will return to normal within a couple of months.

Micron (MU) and Western Digital (WDC) , which are now trading for less than 10 times consensus EPS estimates for their 2021 fiscal years, are another place that bargain-hunting chip stock investors might want to look. While the supply chain disruptions caused by the coronavirus outbreak definitely aren't good for DRAM and NAND flash demand, memory prices (NAND prices especially) had begun rebounding before the outbreak thanks to improved supply/demand balances. And for now at least, the rebound hasn't been derailed by the outbreak.

Buying chip stocks at this juncture undoubtedly requires a strong stomach. Given both the near-term macro environment and how equity markets have been acting, it's quite possible that the group sees additional selling pressure before the dust settles.

But given where valuations now stand for much of the group, and what industry players signaled about demand during earnings season, the risk/reward for many names definitely looks interesting.

Get an email alert each time I write an article for Real Money. Click the "+Follow" next to my byline to this article.

At the time of publication, Action Alerts PLUS, which Jim Cramer co-manages as a charitable trust, was long AAPL.

TAGS: Investing | Technology

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