All Dip and No Chip

In case any of you have been on a New Year's cruise and not touched land since 2005 began, it is earnings season on Wall Street. Time for CEOs to tell their eager shareholders about rising revenues, growing profits, and ballooning share prices. If only it were that simple.

NVE Corp. (Nasdaq: NVEC  ) reported last week, and its CEO announced he was "satisfied with the results... in light of industry conditions." Revenues down, net income down, receivables increased, and inventories increased, and he was "satisfied"?

NVE makes sensors, some of which are used in routers and couplers, based upon its nano-inspired "spintronics" technology, whose nano-scale structures are used for magnetoresistive random access memory (MRAM), proprietary technology the company has been promising will become the backbone of the next generation of memory chips. MRAM is known as the "holy grail" of memory, technology that could let us switch on our computers as quickly as we do our TVs and greatly improve battery life in cell phones and laptops.

At a current share price of $23, NVE is valued at a very generous 54 times trailing-12-month earnings, more than twice the S&P 500 P/E of 22. If you judge this company solely on its modest, albeit profitable, business of selling routers and couplers, it's way overvalued.

Rather, it is the promise of royalty payments from Cypress Semiconductor (NYSE: CY  ) and Freescale (NYSE: FSL  ) that NVE's CEO -- and many investors -- is pinning hopes upon. He expects "new sensors and couplers, as well as MRAMdevices and royalties, to drive future growth." Will that growth come through, and does it justify his company's rich valuation?

A wrinkle in the chip
Unfortunately, Cypress offered little comfort to NVE Corp. and its investors when it reported late last year that the MRAM memory chip it is developing suffers from low manufacturing yield and large size. Both of these problems need to be overcome for it to reach commercial reality. Only then will NVE get any royalties -- or perhaps not even then.

So what of Freescale, spun off from Motorola (NYSE: MOT  ) last year? We take NVE's reluctance to renew a prior agreement with Motorola as a positive sign.

As yet, however, there has been no public announcement of any deal in the offing. Freescale has delivered a working model of an MRAM chip to various preferred clients for trials and were expecting to announce full commercial launch by the end of 2004. That did not happen, so we are still in the dark as to whether Freescale's model infringes any NVE patents or not.

As we reported back in August 2004, when the stock was trading around $35, until we see some public validation of NVEC's technology, there is little propping up this stock even at these much lower levels.

Should the promises materialize, we have a disruptive technology on our hands. And that's when we might consider NVE Corp. worthy of inclusion in our Rule Breaker portfolio. Until then, we'll keep watching -- come and join us.

If you're looking for the next growth company in groundbreaking fields such as nanotechnology, try our ultimate growth service,Motley Fool Rule Breakers.

Share your views with Carl (TMFBreakerCarl) and John (TMFBreakerJohn) on theNanotechnologydiscussion board.

Neither Carl Wherrett nor John Yelovich owns shares of any company mentioned. You can reach Carl and John via email.The Fool has a disclosure policy.


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