Sorting out Semiconductors

July 18, 2006

Most consumers know little about the semiconductor industry and the companies that make the chips inside their favorite electronics. Find out the basics in this comprehensive guide.

The semiconductor industry is packed with complex terminology and hundreds of large companies making specialized products. Here is an overview of what these companies are doing, what devices they are producing chips for, and which stocks appear most favorable on Wall Street.

So what is a semiconductor? It is basically the material that is used in Integrated Circuits, more commonly known as computer chips. The process of making a chip involves etching into a block of semiconductor material, usually silicon. Miniature circuits are created from the carving, which can perform the computing tasks that it is designed to execute.

In a sense, the chip is the brain of computing operations. There is a chip inside your computer, cell phone, DVD player, and countless other electronic devices. The big names in the industry include Intel (INTC) and AMD (AMD), although these companies represent just a portion of the world’s chips.

Intel is well known for its chipsets used in desktop and laptop computers. Intel recently rolled out dual core chips coined Core Duo. These chips combine two processors, allowing slightly lower power consumption and better performance. Apple (AAPL) has signed on to use Intel products instead of chips made by IBM (IBM) in its personal computers and laptops. On the enterprise side, Intel announced that it will release a high-end server chip dubbed Itanium, to be used in computers running websites and corporate networks. The Itanium chips will require an average 100 watts of power rather than the 130 watts that older chips consumed.

Intel has faced stiff competition from smaller rival AMD as better products cut into Intel’s market share. In April 2005, AMD released a dual core Opteron server/workstation processor which offered significant performance advantages over Intel chips. This chip has sold well as it was considered the industry standard until Intel hastily released its own comparable version. AMD has also made inroads into the consumer market, and will soon be used in Dell machines after years of Intel exclusivity. The competitiveness between Intel and AMD has resulted in both better products and a raging price war.

After running up to $42 in February on optimism about its prospects, AMD has lost over half its value as Intel is catching up and releasing competitive products. AMD is still trading at a P/E ratio of 25 and market cap of $10 billion, but the aggressive sales tactics by Intel may hamper its attempts to emerge as a heavyweight in the industry.

Intel has had to deal with its own share of problems with product delays and disappointing earnings results. This has resulted in an awful year for the Dow component, falling down to $18 from $28 a year ago. Intel’s strong brand, cash holdings, and low P/E of 13.9 make the possibility of a turnaround likely. All the bad news may already be priced into the stock, giving it much more upside than downside.

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