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 the smaller, specialized semiconductor companies, but cold on the future prospects of large-cap 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 4,600 stocks rated in CAPS can be "tagged" with a descriptor, grouping the company with others sharing a certain quality.

The "Semiconductor-Integrated Circuits" tag in CAPS includes 75 relevant investments. These stocks have slightly outpaced the market in the past year, up 14.3% versus the S&P gain of 13.2%.

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 five-star stocks our screen pulled up today.

In the semiconductor space, the CAPS community definitely favors more specialized and focused companies. For instance, CAPS investors feel that Motley Fool Hidden Gems recommendation Atheros Communications holds a strong advantage with its focus on wireless communication products. The company continues to roll out healthy earnings results as it increases its market share in next-generation wireless networking technology. While the company's shares are priced at a premium, its nimble size keeps it a step ahead of massive competitors such as Texas Instruments and Intel (NASDAQ:INTC). Many CAPS players think larger competitors will eventually attempt to buy Atheros as well. That's just another reason why CAPS All-Stars favor the stock by more than 100 to 1.

Another specialty integrated circuit provider making the five-star list is power management specialist International Rectifier. The company focuses on proprietary power management circuits -- a popular area lately, given the growing global focus on reducing energy consumption. But IR recently disclosed accounting issues at a subsidiary that was apparently improperly booking revenue, leading to several lawsuits and a slide in its share price. Many CAPS investors smell a turnaround here, though, believing that the company will rectify (no pun intended) its irregularities and beat the S&P going forward. At least, that's the way 97% of players rating the company have voted.

CAPS investors favorably welcomed IPG Photonics with five stars following its recent IPO. The fiber laser market is currently enjoying rapid growth, and investors feel that the company has a strong lead here. It's also benefiting from demand for optical amplifiers from large telcos like Verizon and AT&T (NYSE:T), which are spending billions to build out fiber networks over the next several years. IPG's strong growth prospects have all 49 CAPS All-Stars bullish on the company.

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, covering 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 taking someone else's recommendation. After all, even the best stock pickers can be horribly wrong on a stock.

Do you agree that a wireless chipmaker is the best place to be in semiconductor stocks? Or are power management companies a better play for the future? Give your own opinion in Motley Fool CAPS.

Motley Fool Hidden Gems is a great resource to help find some of the greatest investment opportunities in unlikely places. Discover which stocks Tom Gardner and Bill Mann are recommending today with a free 30 day trial.

Fool contributor Dave Mock loves doing the teardown part -- it's the put-back-together part he hates. He owns shares of Intel. Atheros is a Hidden Gems recommendation. Intel is an Inside Value recommendation. Dave is the author of The Qualcomm Equation. The Fool has a disclosure policy.