While no one was looking, semiconductors stocks started a climb. Three example stocks to look at include Cypress Semiconductor, maker of USB chips and high quality, SRAM memory chips, Altera, another maker of memory, and Xilinx, a maker of field programmable gate arrays (which allow computers to perform certain sorts of calculations very quickly). Looking at their long-term charts:
you’ll notice that they lack the normal long-term growth aspects that are normally favored on this blog. Notice on Cypress in particular the stock tends to go up rapidly and then fall back to earth.
Semiconductors are a cyclical industry instead of a growth industry. While some semiconductor stocks can grow with time (see Cisco (CSCO), and even Altera (ALTR) in the early days), they are subject to the boom and bust of the business cycle. The cycle of the semiconductor is tied to the dynamics fo the industry and are as follows:
1) New chip introduction: A new chip is introduced to the market that is faster, has more memory, or has some other advantages over the previous state-of-the-art. The efficient ways to manufacture the chip are not yet available, so the cost per chip is prohibitively expensive, maybe $2000 per chip. At this point only people who are willing to spend whatever it costs to have the latest gadgets or people like the government who are willing to pay more to get a technological advantages are willing to buy chips.
2) Chip reaches price point of maximum sales: The chip starts to be produced more and more chips are bought and put into devices. More efficient ways to make the chips are developed, driving dow the cost of production marketed. The chip price may be around $4-$6 per chip. It is at this point that the chip makers make their biggest profits. They start to open factories and ramp up production. The stock price spikes at this point as profits grow exponentially.
3) Chip becomes a commodity: Everyone starts producing comparable chips. The price per chip drops to $2 per chip, making it less profitable to sell them. Companies start ramping down production, closing factories, and laying off workers. It is at this point that the bust cycle starts.
Because of this, semiconductor stocks require in-and-out trading rather than long-term investing. The key is to buy these stocks when no one wants them and then hold onto them until they are well into a boom cycle and people are snatching them up. One needs to then exit before the end of the cycle. Expect to miss the peak by several points — it is worth it to get out a bit early because the bust can be severe and quickly erase all of the profits that were made.
TJ Rogers, CEO of Cypress Semiconductor did a study on Cypress stock and noticed something very interesting. He looked for a way to value the stock. He could not use PE ratio, the ratio of price per share to earnings per share, because the earnings were sometimes negative, making this ratio nonsense. Because sales are always positive, he picked price-to-sales ratio, PS, as a marker of price. He found that if he set so value of PS as a buy point, and some higher value of PS as a sell point, he could do very well trading in and out of Cypress stock by buying when the PS dropped below the buy point and selling whenever the stock PS reached the sell point. The most interesting thing about the study was that he made about the same return whether he picked buy and sell PS values that were close to each other or far away from each other. The closer the values were to each other, the more often he would trade (and therefore the more taxes and sales commissions he would pay), so it made sense to set the values fairly far apart. This would mean a trade every year or two.
More about this study can be found on the Cypress website here: http://www.cypress.com/?rID=35390
This strategy does not follow the long-term, wealth growing strategy advocated by this blog; nonetheless, it is worth examining and applying to Cypress and other volatile, cyclical stocks.
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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. In addition the writer of this blog is not an accountant and writings should not be taken as tax advice which should be left to a CPA. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.