TCS Daily


Chips on the Dips?

By James K. Glassman - February 19, 2001 12:00 AM

You may have heard of the "chips on the dips" investment strategy. The idea is to buy stock in the major semiconductor firms whenever their shares fall more than 50 percent below their previous highs.

While the computer-chip business is famously volatile, this industry has averaged close to 20 percent annual revenue growth for decades. So long-term investors have been amply rewarded for putting up with some turbulence. Since semiconductors are the electronic brains of computers and related devices, the chip industry is a great proxy for the growth of the digital economy. Looking ahead, with chips adding intelligence to all kinds of new products, from smart cars to refrigerators that sense when it's time to buy milk, it's not hard to forecast long-term growth.

But in the short term, things look pretty bleak for almost all technology companies. The chip industry, no exception, has entered one of its regular downturns, as it did in 1995 and 1997. And it's not easy to see a turnaround on the immediate horizon. So I should emphasize that you should NOT invest in any chip companies if you're looking to score big gains in the next six months or even a year.

If you'd like to go bargain hunting in this tech sector, I urge you to be an investor in chip stocks, not a trader. If you can wait a while for the gains, history says that this is a wonderful time to follow the traditional "chips-on-the-dips" approach. This means that you buy companies like Intel (INTC), which will soon begin to benefit from its long-delayed 64-bit architecture, National Semiconductor (NSM), which recently traded at $24, more than 70 percent below its high, Motorola (MOT) and Texas Instruments (TXN).

However, there's another lesson of recent chip history that gives me pause. Chip factories, known as fabrication plants, or "fabs" in the trade, are getting more and more expensive. Chips are getting smaller and smaller, even as they grow more complex, with tens of millions of transistors packed into dozens of layers of circuitry on one tiny sliver of silicon. The equipment and the techniques necessary to manufacture chips are staggeringly expensive. It now costs almost $3 billion just to create a factory capable of making the latest chips - chips that could be obsolete in just a few years. I don't like the risk/reward calculus here.

So you might consider a variation of the chips-on-the dips strategy. Look at the new breed of "fabless" semiconductor companies. These are companies that focus solely on designing great chips. They contract out and allow somebody else - usually somebody in Taiwan - to manufacture, test and package the chips for delivery to customers.

The fabless companies don't have to worry about financing, constructing and maintaining a great manufacturing enterprise. They just have to worry about creating great products. Of course, creating great technology isn't easy, but there are a number of fabless innovators that are trading well below their highs of 2000.

Broadcom (BRCM) makes broadband communications chips, chips you might find in a Cisco router, allowing people and companies to send huge volumes of video and audio around the Internet. Broadcom chips are also key components of new digital TV set-top boxes and cable modems, for people with super-fast Internet connections via their cable-TV lines. Broadcom shares have taken a pounding lately on reduced expectations, but this is an innovative tech firm at the heart of the digital future.

PMC-Sierra (PMCS) is another maker of high-performance chips for communications networks that has been punished lately by investors. But like Broadcom, PMCS appears to have a very bright future.

Another chipmaker, Nvidia (NVDA), makes leading-edge graphics chips for PCs and for the new Microsoft Xbox video game console, due to hit shelves later this year. Nvidia is delivering fast growth in revenues and earnings. Silicon Laboratories (SLAB) is a small, profitable firm that could make an attractive acquisition candidate.

Chips on the dips? History says this is a good time to take the plunge. 
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