ETF Teardown: The Best Semiconductor Stocks

Noted for their simplicity and other advantages over mutual funds, exchange-traded funds have become a popular investing tool. ETFs hold a collection of stocks sharing certain common elements. If investors want to capitalize on growth in the broader semiconductor sector, for example, they can turn to Semiconductor HOLDRs or iShares S&P GSTI Semiconductor.

But since these ETFs invest in a number of stocks, their broad diversity also limits your upside. For investors who are really hip to wafer-fabrication companies but cold on the future prospects of power semiconductor firms, these ETFs wouldn't fit the bill.

Fear not, Fool -- in this edition of "ETF Teardown," we'll use some nifty tools to drill into the best stocks in the semiconductor sector. To help, we'll use Motley Fool CAPS, our tool for screening and ranking stocks and stock pickers.

The power of tags
To help investors quickly locate great stocks, any of the 5,000 stocks rated in CAPS can be "tagged" with a descriptor that groups the company with others sharing a certain quality.

The "Semiconductor-Integrated Circuits" tag in CAPS includes 78 relevant investments. These stocks have outpaced the market in the past year, up 23.1% versus the S&P gain of 16.2%.

To gauge which companies the CAPS community considers today's best semiconductor opportunities, we can sort this list by CAPS star rank, from a lowly one star to the highest five-star rating. We can then examine each company to see exactly who -- from Wall Street to Main Street -- is bullish or bearish on the company, and why.

Getting down to the nitty-gritty
Here are a few of the stocks our screen pulled up today.

There are several different ways to invest in the semiconductor space, since few companies perform the whole process from design and fabrication. Many look to specialty suppliers of silicon products and services to handle various parts of the task. MEMC Electronic Materials specializes in the very first stage -- supplying the wafers upon which semiconductor circuits are built. These wafers come in various sizes and materials, and they're supplied to fabrication houses that spin them into a variety of electronic circuits.

While MEMC has grown at a fantastic rate for the past five years, Wall Street still expects the firm to see more than 31% growth in the future, because of the demand for wafers. An increasing amount of that demand comes from solar-cell companies' need for polysilicon wafers.

CAPS investors note that MEMC is one of the few companies with experience supplying large quantities of such wafers. Booked into long-term contracts with big firms such as China's Suntech Power (NYSE:STP), MEMC is scrambling to keep up with their needs. The backlog in demand and the long time frame for new manufacturing capabilities has investors seeing a bright future for MEMC. Indeed, many CAPS investors think this growth comes at a bargain, with bullish All-Stars outnumbering bearish ones 323 to 4.

One of the companies in the next step of the production chain after MEMC is Taiwan Semiconductor. It produces wafers as well, but it also offers the complete manufacturing cycle for a variety of semiconductors -- all the way to a finished, packaged product. In addition to acknowledging the encouraging signs of growth in the semiconductor industry, CAPS investors hold high regard for Taiwan Semi as a result of its forward price-to-earnings ratio of only 13.6, well below the projected 24.9% growth rate. With all of the optimism, the 30-to-1 bull to bear ratio is enough to give Taiwan Semiconductor a top five-star rating in CAPS.

You can lead a horse to water ...
For investors scrutinizing more specialized areas of the semiconductor space, you can quickly find several more specific tags in CAPS that cover areas such as LEDs, specialty semiconductors, and memory chips. Whichever area strikes your fancy, remember to perform your own due diligence on companies, rather than simply take someone else's recommendation. After all, even the best stock pickers can be horribly wrong on a stock.

Do you agree that a wafer manufacturer is the best place to be in semiconductor stocks? Or are fabless design companies a better play for the future? Give your own opinion in Motley Fool CAPS.