Why I Bought OmniVision

Camera-chip maker OmniVision Technologies (NAS: OVTI) has been on my radar -- and my watchlist -- for a long time. The only provider of a more efficient sensor technology known as backside illumination (BSI) is riding the smartphone and tablet crazes like nobody's business. Apple (NAS: AAPL) uses OmniVision's BSI chips in iPhones and iPads. Many high-end Android devices also depend on the low-light efficiency and minuscule power draws of these chips.

Longtime rivals such as Toshiba, Sony (NYS: SNE) , STMicroelectronics, and Samsung had left BSI technology for dead because it's not an easy thing to do. Now they're all playing catch-up to OmniVision's head start, because the little camera-chip specialist spent the time, effort, and money to work out all the kinks. For the next year or two, this company remains unchallenged in the open market even as BSI technology catches smartphone fever.

The time to act is ...
So when OmniVision shares recently dropped 30% in a single day, you bet I paid attention.

My ears really perked up when I saw the reason for the drop. OmniVision delivered yet another estimates-crushing quarter with 43% year-over-year sales growth and nearly double the earnings, so there's nothing scary in the rear-view mirror. But guidance for the next quarter came in a little bit light, so investors and analysts jumped to the conclusion that Apple must have gone somewhere else for the iPhone 5's camera chips.

Curtains. Horror. Someone please pull the fire alarm, because the panic isn't outrageous enough yet.

The same thing happened to Cirrus Logic (NAS: CRUS) last year when unsubstantiated reports placed competing audio chips in the next iPhone. Those rumors crushed Cirrus shares, but were quickly debunked -- and share prices bounced back.

A bargain becomes a screaming buy
OmniVision shares were affordable before the calamitous drop, including a deep swoon alongside the general market panic in early August. Another 30% drop on short-sighted conjecture was the trigger for me -- I had to own this stock.

This wide-open buying window is exactly why I keep a watchlist. Keeping a close eye on your favorite stocks will let you take action when the market gets irrational. It happens more often than you might think.

Let me put OmniVision's deep-discount valuation into perspective for you:

Data from Capital IQ, a division of Standard & Poor's.

I already own Micron shares precisely because they're ridiculously undervalued, but OmniVision's combination of high growth and low prices makes all of these chip stocks look expensive.

Keep your options open
I opened a fresh OmniVision position last week. Mind you, I'm making a short-term trade in Foolish terms by starting a synthetic long options position rather than just buying the stock. In short, I'm so confident of a near-term bounce that I'm willing to put some leverage behind this investment.

I see two catalysts sending the stock higher well before these options expire:

• Apple releases the iPhone 5, iFixit, ChipWorks, and iSupply tear it apart, and find OmniVision cameras inside.

• OmniVision releases second-quarter results in November, proving beyond a reasonable doubt that timid guidance was due to macroeconomic caution and not share loss with Apple.

Call me crazy, call me a gambler, but I like my chances to see both of these catalysts igniting the stock. The last time shares were this cheap, they rested on $600 million of trailing sales and nearly breakeven earnings. Now we're paying the same prices for billion-dollar sales and a 14% net margin.

As long as OmniVision gets back over $21 a share before mid-January, I'll make a tidy profit. If not, my written puts may very well convert into very reasonably priced shares while the calls expire worthless. I'd be all right with that as well, and I also have the option of rolling the position over into longer-term alternatives. This is a darn flexible investment vehicle with very small capital requirements.

Read up on Foolish options strategies here:

• Options: A Foolish Introduction

• Option Strategies: Profit & Loss

• Free Protection for Your Stocks

At the time thisarticle was published

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