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Little-Known Stock Could Deliver 28% Returns at Apple's Expense

Michael J. Carr

Apple (AAPL) is down more than 35% in the past six months making it one of the worst-performing stocks over that period. This rapid decline has also led many traders to question whether AAPL is a buy after falling so much. In my opinion, it might be best to look beyond AAPL for profits.

No one knows for sure what is behind the sell-off in Apple's stock. It could be concerns about slow growth and threats to market share in the smartphone market. Apple's iPhone accounted for 56% of the company's revenue in the most recent quarter.

At first glance, the iPhone seems to be well-positioned. Total iPhone shipments increased by 47% in 2012 to 136.8 million handsets. Apple had 25.1% of the global market share, an enviable position but far below the 39.6% share of first-place Samsung.

This data shows me that rather than trying to find a buying point in AAPL, traders should consider finding companies that will profit if the iPhone loses market share. After all, given the iPhone's market share, we can calculate that more than 400 million smartphones from other companies were sold in 2012. Samsung Electronics (SSNLF) is one possibility for investors, but the stock is thinly traded in the United States and should be considered only by long-term investors.

Suppliers to Samsung, like Spreadtrum Communications (SPRD) could actually be among the best ways to profit from Apple's losses. This company is the fourth largest manufacturer of baseband processors in the world. These processors are key components of smartphones.

Spreadtrum is also the leading broadband processor provider for China's domestic smartphone market, the largest in the world with more than 700 million subscribers. The company is a leading supplier to Samsung, HTC and other manufacturers that stand to gain if iPhone growth slows.

Demand for smartphones has allowed Spreadtrum to grow rapidly. Earnings per share (EPS) have grown at an average annual rate of 70% in the past five years while sales grew an average of 45% a year over that time. Analysts expect EPS of $2.18 in 2013, a 22% gain from 2012. Earnings growth is expected to drop to 16% in 2014 and average only 6% in the next five years.

The slowdown in the expected growth rate in EPS could be one of the factors making SPRD a bargain. The stock is trading with a price-to-earnings (P/E) ratio under 10 based on trailing earnings and 7 based on next year's estimates. Other companies in this industry are trading with an average P/E ratio of 14.

The chart shows the risk of buying SPRD now is relatively low. On the weekly chart, the stock is completing a rounding bottom pattern and moving above the 20-week moving average. Stochastics are bullish and confirming the price action.

SPRD Stock Chart

For a trading strategy we can turn to the monthly chart. Here we see a potential double-bottom pattern forming and stochastics has just completed a buy signal. Resistance near $23 was established late last year and offers a profit target about 28% above the current price. Support at $15 defines the risk on the trade, about 16% below current levels.

In the past, buying after a stochastics buy signal on the monthly chart and holding the position for one year would have been profitable, with an average gain of 100% during the short trading history available on SPRD. That statistic adds confidence to the trading strategy, but the target based on that test seems unlikely given the significant resistance near $23 and the slowing EPS growth.

SPRD Stock Chart

SPRD looks like a company positioned to profit from Apple's troubles. Even if Apple recovers, Spreadtrum is trading at a bargain price and should deliver strong gains to traders in the next year.

Recommended Trade Setup:

-- Buy SPRD above $17.50, to ensure the uptrend is continuing
-- Set stop-loss at $15
-- Set initial profit target at $23 for a potential 28% gain in 6-12 months

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