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Bull of the Day: Cypress Semiconductor (CY)

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The advent of ETF investing in the 1990s with the S&P 500 tracking SPY “spider” shares allowed investors to invest in all the components of a broad market index with a single transaction. Because the shares traded on an exchange just like a single stock, investors could make transactions whenever they pleased – unlike index mutual funds which typically can be traded only at the end of the day. Their popularity soared and their huge traded volumes ensured deep and liquid markets.

Ten years after SPY’s 1993 introduction, there were about 125 ETFs traded in the U.S.. Today there are more than 5,000. Investors can now easily buy and sell exposure to every imaginable segment of the market-  from very broad indexes to very focused sectors and everything in between.

Index ETFs have been a boon to investors, greatly increasing the simplicity and reducing the cost of investing in a passively managed basket of stocks. Arbitrage opportunities ensure efficient market pricing of index ETFs, – if the price of the index diverges from the prices of its components, traders can simultaneously buy the index and sell the components (or vice versa) and keep the difference as risk-free profit – but that can also cause a somewhat adverse effect – correlation.

Inflows and outflows to index ETFs cause the component stocks to move in the same direction, even when the fortunes of those companies are quite different. When investors are purchasing an index ETF in large numbers, the rising tide tends to lift all the boats. When investors are selling, sometimes the baby gets thrown out with the bathwater.

Cypress Semiconductor (CY - Free Report) seems to have been the recent victim of ETF outflow selling. The iShares PHLX Semiconductor Index ETF (SOXX - Free Report) saw outflows of $393M last week including $259 million in a single day. Concerns about softening demand for semiconductors in general, weakening prices due to commoditization, especially in DRAM products, and cautious language from Nvidia (NVDA - Free Report) and Applied Materials (AMAT - Free Report) had investors looking to exit the sector - which has been a strong performer over the past two years.

Cypress, though technically a semiconductor manufacturer, is in a fairly unique niche and it's likely to avoid the pricing and demand issues that are threatening to slow the industry as a whole. CY manufactures embedded systems solutions in four main categories – Consumer goods, Automotive, Industrial and Enterprise Hardware. They make the behind -the-scenes components for a lot of the things in consumers’ homes and cars that work together with minimal input. The fact that Cypress’ products are largely invisible in the end product is – paradoxically – proof that they’re working.

The increasing number of electronic components in automobiles especially plays to CY’s strengths and those components make up more than 30% of gross revenues:

By the Numbers

Cypress Semiconductor, when compared to its peers using Zacks’ advanced research tools, is a true all-star. Eight positive earnings revisions over the past 60 days earn Cypress a Zacks Rank #1 (Strong Buy).

Style scores for Value (B), Growth (A) and Momentum (A) add up to a combined style score of “A”, making Cypress the “best of the best.”

Cypress also compares favorably with its peers in important valuation measures, trading at a forward P/E ratio of just 11.5X versus the SOXX average of 15.5X, a price to sales ratio of 2.5X while the SOXX is at 5.1x, and a price to earnings growth (PEG) ratio of 0.7X while the semiconductor industry trades at an average of 1.2X.

Cypress also pays a dividend of nearly 3% annually, so even if industry growth does stall, Cypress still rewards investors with solid income.

Index ETF investing is an overall positive development for the industry, but can also cause inefficiencies as it can temporarily leave individual stocks over or undervalued as sentiments change. Wise investors recognize when an undeserving company gets punished with a whole group and see it as a discount buying opportunity.

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