Currently, the two most compelling values in the Bull Market Wireless Portfolio appear to be Qualcomn (QCOM, $83) and RF Micro Devices (RFMD,$19). Since we have discussed Qualcomn in this and recent issues, lets focus on RF Micro.
Value is essentially the relationship between a stock=92s price and its expected future earnings stream. The consensus earnings projections for RF Micro for this and next year are $0.32 and $0.42, or 31% growth. Since the consensus 5-year annual growth projection is 42%, we can infer that analysts expect significantly higher growth beyond the fiscal year ending March 2002. Actually, the math works out to be about 45% annual compou= nd growth between March 2002 and March 2005.
Currently, RF Micro trades at a Price-to-Earnings (PE) multiple of 67. However, a better measure of value is the firm=92s PEG (PE divided by Growth), which is 1.58. In comparison, Qualcomn trades at a PEG of 1.8= 8 and Nokia (NOK, $42) trades at 2.13.
So what is a reasonable PEG for RF Micro? Well, given the multiples we 92ve seen among other wireless stocks, we think it=92s reasonable to expect = the stock to trade at a PEG of around 2, which implies a $38 stock price on= e year from now. The stock currently trades for less than $20.
So why is RF Micro such a bargain? We see four reasons for this:
First, size is an important consideration these days. RF Micro has a $= 3.3 billion market cap compared to the industry average of $7.2 billion. Since RF Micro is relatively small, it may be highly dependent on a sma= ll number of customers. Indeed, RF Micro is very dependent on Nokia, whic= h accounts for more than half of sales. Recently, RF Micro has been diversifying its customer base by increasing its business with other important wireless players, such as Qualcomn and Motorola (MOT, $21).
Second, overestimated handset demand has led to an abundance of inventories at some manufacturers, causing RF Micro to lower its foreca= sts for component demand in the current quarter. The stock price dove 38% after the warning on Oct. 18 (to $14.25), but has since gained 46%.
Third, delayed launches of more-advanced cellular phones have slowed sa= les of some of RF Micro's newer products.
Fourth, demand in Korea is still uncertain. Sales to Korea represent l= ess than 7% of the overall mix, down from 15% just a few quarters ago. Kor= ean sales won't make or break RF Micro, but they might limit the growth ups= ide.
We expect a return to normal growth for RF Micro early next year. The market overacted to the earnings warning and provided an outstanding buying opportunity in mid-October. RF Micro has carved a very nice nic= he for itself by becoming a major supplier of power amplifiers, which are essential components in all cell phones. The company's unique manufacturing process gives it a competitive advantage. We also love t= he short action, which has soared from 1.6 million shares in May to 16.6 million shares in October, almost 275% of average daily volume. Short sellers need to eventually buy the stock to close out their position, giving this stock a lot of upside potential. RF Micro Devices looks li= ke a compelling value two quarters away from fruition.