This Just In: Upgrades and Downgrades

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At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

Boo! (Did I scare you?)
In the spirit of the Halloween season, investors got a bit of a scare last week. Noticing that semiconductor inventories were swelling, tech analyst iSuppli suggested that conditions are now starting to resemble those that preceded the "two-year downturn in the semiconductor industry" that began in Q1 2008. Chips are now stacked so high that it would take 83.4 days to move all the accumulated inventory -- the first time they've exceeded 80 days' supply in at least three years.

As if that weren't bad enough, Wells Fargo warned Tuesday that notebook sales are looking weak, too. Contract manufacturers like Compal and Quanta are saying sales volumes were up a bare 2%, "a fair amount weaker than normal seasonality."

Yet it's not all bad news. In Taiwan, it turns out that desktop PC sales at least are holding up well. And yesterday, ace tech analyst RBC Capital came out with a bullish note on semis. Initiating coverage on a raft of semi stocks, RBC argued that when market analysts sound most pessimistic about tech sales, that's usually the time "when chip stocks ... start to shine." Ascribing revenue weakness to "a temporary 2.5-3 quarter inventory correction post-Japan," RBC argues that far from falling victim to an inventory glut, "the semiconductor industry could already be under-shipping real consumption levels."

Putting its clients money where its mouth is, RBC therefore started with SanDisk (NAS: SNDK) -- its top pick in the industry -- and then proceeded to assign outperform ratings to each of Cypress Semiconductor (NYS: CY) , Marvell Technology (NAS: MRVL) , Analog Devices (NYS: ADI) , Texas Instruments (NYS: TXN) , and Intel (NAS: INTC) .

But is RBC right? Will these stocks beat the market?

Let's go to the tape
I really do believe they will -- most of 'em, at least. Why do I say this? Well, first of all, because of RBC's record. Of this analyst's active recommendations in the semiconductor industry, 64% are beating the market. That's a pretty impressive scorecard, and it has me feeling optimistic about the picks going in. And the more I look at these stocks, the more I like them. (Again -- most of 'em.) Here -- take a look for yourself:

Company

P/E Ratio

Forward P/E

Projected Growth Rate

Free Cash Flow (As a Percentage of Net Income)

SanDisk8.49.514100%
Marvell12.19.915.4118%
Cypress2210.917.6153%
Intel10.69.41171%
Analog Devices11.812.91089%
TI11.412.410.580%


To begin with, each of the companies RBC picked yesterday is pegged for growth rates in excess (in some cases, far in excess) of the 9% long-term earnings growth rate more common among Dow Jones Industrial Average (INDEX: ^DJI) stocks. Even so, the P/E ratios -- which range from the mid-9s to the upper 12s -- aren't at all out of line with the 11.2 forward P/E ratio of the Dow.

Simply put, the prices are reasonable -- much more so than you might expect given the growth potential.

Foolish takeaway
As for which of RBC's picks has the most potential, I'm going to have to split my decision. I agree with RBC that SanDisk is probably the best bargain on this list, which is why I own it. But I also like the valuations at Marvell and Cypress quite a lot. Both are growing at rates far faster than needed to justify their modest P/E ratios. Both generate more than enough free cash flow to back up reported net income.

As for Intel, Analog, and TI, the valuations here also look reasonable to me. Not cheap, exactly, but reasonable. If they were just a bit more efficient on the free-cash-flow front, I expect I'd be recommending these companies today as well. Then again, seeing as RBC has already pointed out to us three of the best bargains in chip stocks today ... why be greedy? Once you've found the best, why bother with the rest?

Looking for ways to diversify and hedge your bets beyond a single-industry semiconductor focus? Read our free report on3 ETFs Set to Soar During the Recovery.

At the time this article was published Fool contributorRich Smithowns shares of SanDisk.You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 300 out of more than 180,000 members.The Motley Fool owns shares of Intel, Texas Instruments, and Marvell Technology Group.Motley Fool newsletter serviceshave recommended buying shares of Cypress Semiconductor and Intel and creating a diagonal call position in Intel.We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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