Grab Intel in the new tech rally

By Jon Markman

Summer is supposed to be the time of lounge chairs and beach balls for the stock market, but someone apparently forgot to tell technology investors. For the first time in years, the world's largest computer companies are strutting across Wall Street with an undeniable swagger, as second-quarter earnings are likely to come in above expectations and shares are sweeping to multiyear highs.

It's not just the iPhone, either. It's notebook computers, set-top boxes, networking equipment, enterprise servers and high-definition televisions. It's operating systems, digital cameras and DVD players. It's RAM and flash memory. Indeed, despite bears' forecasts that a plunge in residential real-estate values would scare off consumer and business spending, the demand for things that plug in, turn on and help you tune out are as strong as ever.

Have you taken a glance at the Nasdaq Composite ($COMPX) lately? It wasn't but a couple of months ago that the strength of the Dow Jones industrials ($INDU) were all anyone wanted to talk about. But suddenly, and rather quietly, here in July the Nasdaq has slipped into the lead among the major indexes for the year, the recent stumble notwithstanding. It has clocked a rather stunning 10% return so far in 2007, compared with 7% for the S&P 500 ($INX).

Unsung stock heroes

"Stunning" seems like the right word because the Nasdaq hasn't busted a move like this for three long years. In 2006, the tech-heavy index peaked briefly with a 10% gain for the year in November but then slacked off and ended the year up only 8%. In 2005, it peaked at 5% in November and ended the year up 2%. In 2004, it peaked at 7% at the end of the year. So a 10% advance in six months should definitely get your attention.

Much of the strength of the Nasdaq can be laid to the surges at Apple (AAPL, news, msgs), BlackBerry maker Research In Motion (RIMM, news, msgs), Internet retailer Amazon.com (AMZN, news, msgs) and alternative-energy providers First Solar (FSLR, news, msgs) and SunPower (SPWR, news, msgs), which have seen shares rise 50% to 200% this year. But there are a whole bunch of unsung heroes in the Nasdaq that deserve your attention as well, as they could provide a lot more fireworks this summer and on into the rest of the year.

The semiconductor sector should be right at the top of your list, headed by the newly invincible Intel (INTC, news, msgs). Skeptics and rivals have tried to kick this company down the stairs, but it keeps coming back. It's already up 24% this year and could easily advance another 30%-plus if its valuation were to catch up with its undeniable earnings growth. The key driver for Intel, I believe, will be a surprisingly fast ramp-up in the second half of the year to support Microsoft's (MSFT, news, msgs) much-maligned Windows Vista operating system.

A Cowen & Co. study found that two-thirds of large businesses and three-quarters of small businesses plan make the switch to Vista over the next 12 months after Microsoft publishes its first Service Pack, a collection of patches and enhancements that fix a bunch of bugs found in the software's initial release. Most plan to implement Vista via new computers, not by upgrading existing machines -- leading to a surge in demand for the Intel chips that serve as their brains. (Microsoft owns and publishes MSN Money.)

Meanwhile, PC makers are reporting that they expect orders to be stronger than normal in the coming back-to-school season, with an exciting new range of products from Dell Inc. (DELL, news, msgs), Sony (SNE, news, msgs) and Apple.

Cost savings inside

Intel is very well positioned for this change in the demand cycle, as its larger and more advanced factories will give it a leg up on archenemy Advanced Micro Devices (AMD, news, msgs). Intel operates four microprocessor foundries, or "fabs," in the United States and Ireland. Two new fabs are scheduled to open in the next couple of years, including one in Israel, which will be able to manufacture processors with a more efficient process than the one currently used. So by the end of 2008, Intel will operate six fabs in all, four of which will operate on the advanced 45-nanometer process. Analysts expect this to slash production costs by a fifth, pushing gross margins much higher to nearly 60%, up from the current 52%.

With this expanded, low-cost production base, Intel will be able to competitively cater to users in developing nations, which already make up 40% of annual sales. In fast-growing nations like Brazil and Russia, there are only about 10 computers per 100 members of the population, according to a United Nations study, compared with 76 per 100 Americans.

Continued: More reasons for optimism

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