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Variety Is The Spice Of Semiconduction

Posted: Aug 13, 2008 15:13 PM by James Brumley

Tickers in this Article: SMTL, ASX, ACLS, CREE, AMAT

If you've seen one semiconductor materials stocks you've seen them all, right? Perhaps not. Cree Inc. (Nasdaq:CREE) and Applied Materials (Nasdaq:AMAT) may both be in the same business, and they both may have reported earnings on Tuesday, but that's where the similarity ends.

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These are two companies headed in very different directions. Cree has had all the hype, but as we'll see, Applied Materials is the stock to watch.

Industry Grab Bag
This industry still isn't uniform enough to simply pick one out of a hat. Some of the recent announcements include Axcelis Tech. (Nasdaq:ACLS), Advanced Semiconductor (NYSE:ASX), and Semitool (Nasdaq:SMTL). Axcelis fell short of expectations, while the latter two topped analyst estimates. The mixed bag has been a common theme this entire earnings season.

And the stocks? We'll, they've been lethargic and haven't participated in the modest market rally. We can't assume anything with this group right now. Now let's move forward with Cree and Applied Materials.

Results Vs. Expectations
They say perspective is everything. That's certainly true when it comes to stocks. Take the number analysts expected from Applied Materials for instance. Analysts were only looking for a profit of 14 cents per share this quarter, which is well under last year's third-quarter profit of 37 cents per share. Still, even with that dip in earnings (thanks to a lull in sales), the stock's trailing twelve-month price-earnings multiple would be 20.2 with those results.

Cree, on the other hand, was initially expected to earn 9 cents per share. This translates into a P/E multiple of 51.5!

So, how'd they do? Cree performed as anticipated, earning 9 cents per share on record revenue of $135.9 million for the quarter (or 13 cents, allowing for one-time expenses). Applied Materials also posted numbers that were even poorer than anticipated. Profits for Applied Materials' third quarter sank by 65%, to 12 cents per share, two pennys short of expectations.

Cree shares went ballistic in after hours trading following the announcement, rallying as much as 8.4% above the closing, pre-announcement price. Applied Materials saw its shares rally by almost 4.0% in the evening trading session despite failing to meet estimates.

In Applied Materials' defense, however, it would have turned in a profit of 14 cents had it not been for acquisition-related expenses, and so, effectively, both companies met or exceeded analyst targets. (To read more on earnings results and how they can send stocks moving, check out Surprising Earnings Results.)

Cree on Borrowed Time?
Congratulations to both companies, but the situation forces me to ask, how can one company's stock (based on a P/E ratio) be worth more than twice as much as the other? You could say growth, but frankly, both companies are forecast to grow their top and bottom lines at about the same rate.

I think this is just one of those cases where hype has a bigger impact than performance. Cree was an expensive stock just because a history of being overpriced became the norm. If you think a price-to-earnings multiple of 51.5 is crazy, Cree shares were almost twice as expensive in February.

Applied Materials didn't have the same history, but here's the rub: Eventually, every company has to justify its stock price. It may not be today, tomorrow, or even next month, but, eventually, they all have to. (To learn more, read our P/E Ratio Tutorial.)

The Eternal Battle - Style or Substance?
Given the choice between the two, I'll take Applied Materials over Cree until further notice. There's no doubt Cree has set the LED world on fire with great, and high-margin, products. However, where Cree may be facing a situation where it will be challenged to live up to expectations, Applied Materials has a good chance to turn its value (i.e., low P/E metric) into something good for shareholders in the foreseeable future.

Applied Materials already followed up on the earnings announcement with news that it expects a better fourth quarter, with revenue somewhere between 2-10% higher than this quarter's numbers. Longer-term, solar power materials are expected to be the key drivers of their growth. There's still some growth potential though, which is something Cree may not have as much of.

In the bigger picture, it's just a reminder that (1) values still exist, and (2) there's always more to the story than just one quarter's actual results versus the expected results.

By James Brumley

James Brumley is a freelance writer and registered investment advisor. He began his career as a broker with a major Wall Street firm, where fundamentals and long-term holding periods were core strategies. After that, he switched gears completely, becoming an analyst at a short-term trading newsletter that focused on technical analysis. He now manages client money using the best of both philosophies. His company, Bluegrass Portfolio Management, offers investors an opportunity to reap superior returns with minimized risk.

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