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Buy, Sell, or Hold: Entropic Communications

When considering any stock for your portfolio, don't be swayed by just the positives. Examine its pros and cons, and decide whether its possible upsides outweigh its risks. Let's take a look at Entropic Communications (Nasdaq: ENTR  ) today, and see why you might want to buy, sell, or hold it.

The company is in the microchip business, with its wares residing in electronic devices that communicate with each other, such as computers, routers, TVs, DVRs, stereos, video game systems, and more.

There's a lot to like about Entropic. Consider, for example, that its revenue has been growing, on average, by double digits -- 33.8% over the past five years and 14.5% over the past one year. Its net profit margin is an attractive 11%. Its debt load is appealing, too, as it carries no long-term debt.

The company's valuation is attractive, too, with its forward price-to-earnings ratio recently at 10.5, compared with 13.4 for the S&P 500. Its PEG ratio clocked in below a roughly fairly valued 1.0, too, at 0.9.

A look at the company's potential is encouraging, too. Entropic has deals in place with companies such as Intel and Zoran, to develop new products such as components for set-top boxes. (It also acquired Trident Microsystems' set-top box assets after Trident filed for bankruptcy protection.) Its designs feature collaborations with companies such as Qualcomm and Marvell Technology.

Meanwhile, those who have shorted the stock, expecting it to fall, have shrunk in number. The number of shares shorted has dropped by more than half over the past year, suggesting that the company's future looks more promising.

Every company has its negative points, though, and Entropic is no exception. Remember that strong revenue growth rate? Well, it's strong, but it's also shrinking, growing less rapidly in recent years. That's not necessarily a deal breaker, as few companies can keep up hefty growth rates over the long run. As a company gets bigger it can become harder to grow quickly. Entropic is not weighed down with debt, as many companies are, but its cash and short-term investments have been trending downward in recent years. Ideally, we'd like to see that moving in the other direction. Still, unlike many companies, it does have plenty of cash. That is a good thing.

That 11% net margin is great, but it's down from around 31% in 2010, and it was negative in a bunch of years before that. In other words, Entropic is delivering lumpy numbers; it's not for those seeking consistency.

Its stock is volatile, too, exhibiting a beta of 3.6, which means it rises and falls much more sharply than the overall market. (This isn't a big deal to most Fools, though. As long as a company's overall trend is up, or is expected to be upward bound, it shouldn't matter too much how zig-zaggy its ascent is.)

A danger for many companies is being very dependent on one or a few customers. This was evident with Entropic last year, when its sales to Verizon (NYSE: VZ  ) slumped (due to much-lower-than-expected demand for Verizon's FiOS service), and its stock slid more than 30%.

You might also just want to wait, when it comes to investing in Entropic Communications. You might wait for electronically connected homes to become more of a widespread phenomenon than just a promising prospect. You might want to see a series of quarters in which Entropic posted growing revenue, earnings, and profit margins.

The verdict
The case for Entropic seems mixed to me, with compelling reasons to buy or wait. I actually bought some shares in the last year, and have seen them sink nearly 30%. I made a bullish call on the company on My CAPS page, as well. There are better options in tech investing at the moment. The Motley Fool recently issued a research report detailing three overlooked winners of the coming "post PC" boom. We made the report absolutely free to our readers as well, so just click here to access your free copy today.

Longtime Fool contributor Selena Maranjian, whom you can follow on Twitter here, owns shares of Entropic Communications, Qualcomm, Verizon Communications, and Intel, but she holds no other position in any company mentioned. Click here to see her holdings and a short bio The Motley Fool owns shares of Intel and QUALCOMM. Motley Fool newsletter services have recommended buying shares of Intel. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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