Building A Tech Recovery Portfolio

The market is range-bound these days. It doesn’t want to go down because it has already corrected much of the excessive happiness of early January. It doesn’t want to go up because of rising interest rates and the uncertainty over how high they’ll climb.

This past week didn’t ease concerns over interest rates. On Friday, the February employment figures were released. They were roughly along expectations. Payrolls were up 243k. After a downward adjustment of 18k to previous months, the net 225k gain was just a tad higher than the anticipated 210k rise. Hourly earnings rose 0.3%, right on target.

The report is good for the economy because solid employment and wage increases fuel growth. However, the report means precisely nothing in the debate over when the Fed will stop raising rates.

The market is anticipating two more increases for sure, and potentially a third. It’s that third one that has people wringing their hands for two reasons. First, because they can’t get a grasp on the odds of it happening. Second, because if it does happen it will crimp business spending significantly. To now, we’ve been getting back to normal from a long period of low, free-spending rates. Three more rate increases from here, though, and we will have moved past normal into restrictive.

Another factor to watch is bond yields. Prices and yields move in opposite directions. When a stock or bond drops in price, its yield goes up. Therefore, something with a high yield is seen as a bargain, or at least less risky than something with a low yield or no yield at all.

For the past three weeks, the 10-year U.S. Treasury Note’s yield has been rising. Two weeks ago it stood at 4.57%. Last week it rose to 4.68%. This week it rose to 4.76%. If it keeps moving higher, bonds will become more attractive to investors than stocks. Money moving from the stock market to the bond market could push stock prices down. There is no forecast to be drawn yet, but I’ll keep an eye on the 10-year note’s yield.

Oil poked its head into newspapers again this week after OPEC said it would maintain current production levels. The price of crude slipped under $60 for a moment, but closed the week at $62. That’s a dollar less than last week, but solidly in the recent price range.

Let’s have a look at some individual investment themes, starting with the company we bought last Wednesday.

Semiconductor Equipment Maker
We bought Investments are shown only to KELLY LETTER subscribers. Click to try the letter for one cent. on Wednesday at $18.

Since January, the company has received four analyst upgrades:

Feb 03, Soleil, from Hold to Buy
Feb 08, Banc of America, from Sell to Neutral
Feb 14, AG Edwards, from Hold to Buy
Mar 06, CIBC, from Sector Perform to Sector Outperform

The stock hit a high of $21.06 on Jan. 12 and has a 50-day moving average of $19.16.

Consensus forecasts show sales and earnings improving over the next two quarters. The average one-year price target is $23.74. Getting there from $18 would give us a 32% gain. I expect, however, to get to $27 for a 50% gain.

A month ago, the company beat earnings projections by growing more than 20%. Then, contrary to recent trends, it guided second quarter projections higher. It said that it expects orders to increase by 15-20%, double its previous estimate.

The stock has lagged its industry, but that’s going to change. Foundries are increasing their capital expenditures. Both United Microelectronics (UMC) and Taiwan Semiconductor (TSM) reported high revenues and utilization rates last quarter. A 13-page, $6,995 report (no kidding) from Gartner published on Jan. 19 concluded that:

After two consecutive quarters of strong growth, the foundry market will suffer a seasonal dip in the first quarter of 2006. Demand orders are thereafter expected to improve gradually, pushing the industry utilization rates above 90 percent by the fourth quarter of 2006.

That means those foundries will need more and better equipment to make future generations of semiconductors. This company makes, sells, and services that equipment. Sales by geographic region in fiscal year 2005 were as follows: Taiwan 23%, North America 21%, Japan 20%, Korea 14%, Europe 13%, and Asia-Pacific 9%. Asia accounts for some 80% of sales, so positive reports on revenue and utilization, like those above from Taiwanese companies, are positive for this company as well.

Management has done a good job. The company’s debt is in line with industry averages and its finances are solid. Cash flow is positive. Demand for its products and services has been strong. Last quarter, sales grew 4.3% to $1.86 billion.

Standard & Poor’s maintains a 12-month price target of $26. From its March 6 stock report:

Our recommendation is buy. We expect momentum will continue to build through 2006 and see industry sales increasing 10%. We believe the semiconductor industry experienced demand weakness starting in the second half of calendar 2004. This trend reversed beginning in the second half of 2005. Management has noted that Japan and Taiwan continue to be a strong source of demand. DRAM prices have also started to increase, which is positive. We see Investments are shown only to KELLY LETTER subscribers. Click to try the letter for one cent. as having the technological expertise and economies of scale to benefit from these global trends.

I’m happy to be riding this wave with this company. If you have not bought yet, there’s still time. The stock closed the week 1.2% lower than The Kelly Letter paid.

I have fresh updates on Intel, Japan, RadioShack, and the 2nd Half 2006 PC Recovery, for which we’re positioned in the top three companies. Only one of those three is substantially higher than the price I paid. That means now is a good time to try The Kelly Letter.

In your welcome notes, you’ll see the semiconductor equipment company I just bought and which you can buy 1% cheaper than I paid. Plus, you’ll see which three companies I’m betting on to benefit from the PC upgrade cycle later this year. One of them is trading 10.5% lower than I paid and one is a mere 0.3% higher.

This is almost always my approach: patience awaiting deep value. There is no doubt in my mind that the positions we’re building now will turn into winners, just like our last four sales. Did you see those listed in the Kelly Command Center at the top left of this page? Here they are again:

Mitsubishi UFJ Bank +5%
Ariba +60%
Maxtor +60%
Decker’s Outdoor +40%

Every one of them traded below my initial buy price before eventually rising to excellent gains. I’m repeating the pattern again, and hope that you’ll join me before we’re halfway to the final profit.

Would you like to have a look? The first month is only a penny, and then just $5.48 per month thereafter. Bet you didn’t know leading information could be so affordable. It is here. I hope to welcome you soon.

You can read more about the letter and sign up for your one-cent month on the Kelly Letter information page.

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