Stock Idea: Semiconductor Capital Equipment Stocks

(May 16, 2011 update: All future stock posts will appear on my new subscription-only website at www.GoodfellowLLC.com. Please visit!)

Today Morgan Stanley research covered the Semiconductor Capital Equipment industry. Morgan Stanley is more bullish on the industry than the street is, and having worked there, I'll go with Morgan Stanley research over the street any day of the week.

"While most view 2011 as a cycle peak, we expect equipment spending to remain elevated through 2011-12 on rising capital intensity and higher smartphone plus tablet unit demand. We think group multiple still has room to expand trading at 10x MS CY11 estimates versus historical trough average of 13x, a discount we think is unwarranted given our rising capital intensity view. Our top ideas are AMAT ($16.46), LRCX ($56.10) and ASML (€32.15)." -- Morgan Stanley & Co. Inc. and Morgan Stanley & Co. International, February 22, 2011.

What this paragraph says to the novice is that Morgan Stanley analysts expect these stocks to do well because (a) there is more of a demand for the products than Wall Street is currently expecting and (b) the price/earnings (PE) ratios are lower than normal on these stocks. PE ratios are a key valuation measure.

Let's look at the three stocks mentioned in the research.

Applied Materials, Inc. (AMAT, $15.72) -- The PE based on 2011 projected eps of $1.27 is 12.38. There is a dividend of $0.28, which yields 1.78%. This stock suffered repeatedly during the last decade, topped off by the financial meltdown of 2008. It's a good buy right now, with $15. per share about the best price you're going to get, barring unforeseen bad news. Expect some upside resistance at $18, $20 and $22.

Lam Research Corp. (LRCX, $54.34) -- The PE based on 2011 projected eps of $5.93 is 9.2. Based on trading patterns, and a previous high of approximately $60, I would watch for a pullback to $47, then buy the stock, and definitely sell as it approaches $60.

ASML Holding N.V. (ASML, $43.61) -- The PE based on 2011 projected eps of $3.67 is 11.9. There is a dividend of $0.458 per share, which yields 1.05%. After a decade of trading up and down, ASML broke out of that trading range this past fall. There is strong support at $36. I would be please to buy this stock on a pullback to $38, then use stop loss orders to protect my profits as it rose again.

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