3 Reasons Why This Chip Stock Is Worth Buying

Up 20% this year, this chipmaker looks primed for further gains.

Jul 7, 2014 at 3:00PM

Chip maker Atmel (NASDAQ:ATML) has surprised the Street this year with gains of 20%. At first, the stock looks overpriced at almost 144 times last year's earnings, considering that revenue was up just 2.5% year over year in the first quarter. However, a closer look at Atmel's financial performance reveals that it could be a good buy, despite a high earnings multiple, because of improvements in the business.

Atmel is also well-positioned to benefit from Cisco's (NASDAQ:CSCO) Internet of Things, while stability in the PC market should allow it to profit from its Microsoft (NASDAQ:MSFT) tie-up. In all, there are three simple reasons why Atmel might turn out to be a good long-term bet.

The Internet of Things
According to Goldman Sachs, Atmel is among the best-positioned companies to benefit from the Internet of Things. Goldman believes that Atmel's expertise in the microcontroller business will come in handy in the IoT era, and the chipmaker's recent product development moves also suggest the same.

The company is providing IoT solutions with its SmartConnect family of products. Recently, Atmel expanded its IoT portfolio with new SmartConnect SAM W23 modules, which enable Wi-Fi connectivity and deliver high-performance and low-power technology for IoT applications. Also, Atmel believes that the SmartConnect family will lead to a drop in development times for manufacturing cost-effective, battery-operated industrial applications. 

Since the company targets a broad range of IoT applications, from machine-to-machine communications, home and building automation, LED lighting, to wearables, it claims to have the most complete portfolio of IoT technologies. Such an extensive portfolio will allow Atmel to benefit from a multi-trillion dollar opportunity.

Cisco is trying to make the world a more connected space to boost its revenue opportunity. Last year, the networking behemoth was facing a slowdown in its core router and networking gear business, and expects the Internet of Things to be its savior. As such, Cisco is investing aggressively in this concept, unveiling solutions such as "fog computing" to stop resource wastage in IoT applications. In addition, Cisco has begun investing in early stage companies to spur IoT deployment.  

By 2020, Cisco believes that there will be 50 billion connected objects, giving birth to a $19 trillion opportunity. Now, to interact with each other, these objects will need efficient connectivity solutions with longer battery life. Atmel is trying to do just that with its microcontrollers.

PC stabilization is good news
According to Gartner, worldwide PC shipments in the first quarter of 2014 were down 1.7%. The market-tracking firm stated that "severity of the decline eased compared with the past seven quarters," primarily due to Microsoft stopping support for Windows XP.

On the whole, the PC market is expected to do better in 2014 than last year, according to IDC. The market is expected to decline just 6% this year, whereas it fell 9.8% last year. This bodes well for Atmel, as its microcontrollers are qualified with several Windows devices.

In addition, Microsoft is preparing to roll out Windows 9, and it is targeting core desktop users and mobile with this product. The company will work to redesign the operating system to make it more context-aware, according to ZDNet. In addition, the OS is expected to behave in different ways, depending on the device. If Microsoft is able to deliver a solid improvement with its next OS, users might find another reason to upgrade, pushing up sales of computers in the process.

Valuation and fundamentals
As mentioned earlier, Atmel trades at an expensive earnings multiple. But, on a forward P/E basis, the stock seems cheap at a multiple of 15. In addition, Atmel has a strong balance sheet. The company is debt-free, and has a strong cash position at $255 million. Moreover, earnings growth projections are highly positive.

Next year, the company's earnings are expected to grow 41%, while for the next five years, the expectation is for an annual growth of 17.5%. As such, even though Atmel might be expensive as of now, solid earnings growth is in the cards. The company is rapidly improving its bottom line already. For example, net income came in at $2.2 million last quarter, a massive improvement over a loss of $47.7 million in the year-ago period.If Atmel is able to sustain such an impressive rate of growth, there's no doubt that it can be a good long-term buy given the end-market prospects.

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Harsh Chauhan has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems. The Motley Fool owns shares of Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

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Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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