The Booming Trend That Could Drive This Semiconductor Giant Higher

The personal computer, the Internet and mobile devices all revolutionized our society. But over the past two or three years, it seems the pace of innovation has slowed — at least for consumers. Yes, we’ve seen the introduction of better, faster smartphones and variations on the theme such as smart watches. But what’s next?

The answer, technologists say, is the “Internet of Things” — a new wave of real-world uses for smart technologies such as networking, sensors, GPS, data collection and management, and the like. The idea is to make more machines “smart.”

The most commonly cited examples are Fitbits, which monitor exercise stats and store them as data for later analysis. When you use your smartphone to turn up the thermostat remotely, you’re using the Internet of Things. Less popular so far, but on the market: smart tennis rackets, saucepans and silverware (spoons that tell you how much soup or ice cream you’ve eaten).

While some of these products seem more fanciful than practical, experts agree that there’s huge room for growth in Internet of Things (or “IOT”) applications. For example, manufacturing costs may be reduced significantly by efficiency improvements brought by machines that are not only automated but communicating with each other. Smart thermostats and energy sensors can reduce wasted energy across industrial, commercial and residential spaces. GPS applications can be used to keep track of pets and children. The list goes on and on.

The number of connected devices with IOT applications will rise from about 5 billion this year to 20 billion by 2025, according to respected research firm Gartner. And one thing each of those devices has in common is semiconductors.

The Demand For “Smart” Products Will Drive The Semiconductor Industry
Semiconductors enable the operation of microprocessors, which are the building blocks of computers and other smart devices. Not surprisingly, the industry has grown tremendously over the past 50 years, but in highly cyclical fashion. Its leaders rise and fall as they introduce ever-smaller but faster, more efficient microchips for use in personal computers, servers, cable boxes, TVs, video game consoles, phones, tablets and other smart devices — only to be leapfrogged in short order by competitors, forcing extreme price competition for older semiconductors that quickly become commodity products. It’s a tough business. But it’s been a rewarding one for investors over the long haul because of the long-term secular growth of products embedded with smart chips.

In my view, the IOT revolution is both overhyped and underestimated. The impact it will have on consumers’ everyday lives is probably exaggerated, but the potential for a “behind the scenes” rehaul of industrial processes is enormous. So I think the leading semiconductor stocks will benefit.

There’s one more wild card to mention: smart cars. This is one area in which consumers may indeed see real change, as high-tech systems once considered luxury items become table stakes for automakers: anticipatory braking, self-parking, tire-pressure monitoring, built-in GPS, etc. The automotive semiconductor market has grown about 8% a year to more than $24 billion today. And if fully automated cars become commonplace, their systems will be embedded with microprocessors far more sophisticated than those on satellites and airplanes just a decade ago. So any semiconductor maker with leadership in auto applications gets a “plus” in my book.

Somewhat surprisingly, the best-looking semi stock based on these criteria is the sector’s 800-pound gorilla.

Intel (Nasdaq: INTC) has recovered from its hiccup of a few years ago in which it failed to invest in chips for tablets. Analysts think the company is poised for renewed growth. Always the industry leader in research & development thanks to its prodigious cash flow, Intel has invested heavily in new products for servers to solidify its data center and cloud computing leadership positions. It also invested $16.7 billion of excess cash in the acquisition earlier this year of Altera, a leader in programmable chips used by data centers. Some analysts think Intel’s PC business will do better than expected in the coming quarters thanks to stronger-than-expected laptop sales.

And Intel seems committed to growing its IOT business, which still accounts for only about 3% of revenue. Its cutting-edge semiconductors used for cloud computing and servers will help Intel grow market share in the fast-growing industrial IOT market. And it is solidly positioned in the auto space: Intel is working with Ford, Toyota, Hyundai, BMW and many other automakers on a range of smart car technologies.
Intel’s stock has muddled along in recent years, and as a result it’s now reasonably valued at less than 15 times next year’s earnings estimate and with a 3.5% dividend yield. But this is a good opportunity to accumulate shares of a market leader in an industry sure to enjoy long-term growth, cycles or no.

Risks To Consider: Intel is susceptible to concerns about a slowing economy, including in China.
Action To Take: Buy Intel below $35.50.

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