Analog: All That and a Bag of Chips?

It was the best of times, it was the worst of times. It was the age of wisdom, it was the age of Foolishness. As the analog chip sector crawled out from under the rubble of a collapsed market, it was time to compare and contrast, and to find the best investment opportunities.

And that, my friend, is where you come in.

Analog Devices (NYSE:ADI) just reported third-quarter earnings. The results show clear signs of recovery, quarter over quarter, and it seems only fair to assume that the worst is over. In this, Analog is far from alone; rivals like Texas Instruments (NYSE:TXN) and Broadcom (NASDAQ:BRCM) have already shone their lights on the same trend.

To be precise, Analog saw revenue rise 4% from last quarter, landing at $492 million. Earnings jumped farther and faster, increasing 22% sequentially to $0.22 per share.

But Analog is having trouble in the margin -- the gross margin, that is. That metric shrank by 100 basis points from last quarter, moving from 55.1% to 54.1%. High-margin industrial and telecom customers have relaxed their ordering activities lately, while less profitable consumer-products customers picked up the slack. The bottom-line improvement in the face of such shrinkage points to strong cost controls on the operational level. Those trimmed corners and tightened bolts should serve Analog well in the future, as a leaner and meaner company takes on refreshed opportunities.

Gross margins greater than 50% are still pretty nice; Texas Instruments and STMicroelectronics (NYSE:STM) would sell their aunts for that kind of profitability, and Broadcom might at least chip in drunk old Uncle George. But Analog is far from the king of that hill of profitable beans.

National Semiconductor (NYSE:NSM) sported 58.3% gross margins last quarter and 62.7% over the last 12 months. And Linear Technology (NASDAQ:LLTC) hovers around the 75% mark. Think about that for a minute.

The average million-dollar order for Analog brings in $541,000 to fuel operations and filter down to the bottom line. Linear is doing about 40% better than that. Strong margins show pricing power, which means that customers see something extra -- something better -- in Linear's products. Linear (like Analog) is perceived by many as a defensive play thanks to its relative stability and industrial exposure. As news of an economic recovery gained momentum, investors piled into lower-quality companies, but I think you’d be mistaken to ignore these analog technology giants -- especially Linear, with its focus on feature-rich, high-margin items and strong performance during the economic doldrums.

That pricing power is one of the reasons why Tom Gardner recommended Linear to his Motley Fool Stock Advisor subscribers last year. He had plenty of reasons to love that stock, and they still hold true today. Find out exactly what Tom saw with a free 30-day trial pass to our flagship newsletter service.