Look around and you will find semiconductors everywhere.

The Semiconductor industry serves as a driver, enabler and indicator of technological progress. Developments in the industry determine the way we work, travel, communicate, entertain ourselves and respond to our environment. From the PCs we work on, the cars we drive, the phones we use, the electronic gadgets on which we watch movies, listen to music or play games, to the planes and weaponry used for transportation and protection, use semiconductor devices.

And it seems almost paradoxical that semiconductors have dragged the broader technology sector for the good part of this year.

 When the economy is improving, people tend to buy more electronics.

According to Canadian Business, historically, the sector’s earnings growth has run at double the rate of gross domestic product (GDP) growth. However, the picture changes completely when the economy contracts or grows slowly.

Present Scenario of the Semiconductor Industry

According to Gartner Inc., worldwide semiconductor revenues in 2015 are predicted to decline 0.8% to $337.8 billion from 2014. This marks a major revenue decline since 2012 when the market shrank 2.6%. Previously, Gartner predicted 2.2% growth.

The U.S. economy faces several headwinds at the domestic as well as global level. On the domestic front, real GDP adjusted for price changes, slowed to an annual rate of 1.5% in the third quarter of 2015, down from 3.9% growth recorded in the previous quarter.

Also, the Oct 28 release of the U.S. Federal Reserve reaffirmed the interest rate at 0–0.25%, though it acknowledged the increasing economic activity in the country. However, uncertainty regarding the December rate hike decision continues to weigh on the overall market sentiment.

Global economic headwinds, like the slowing Chinese economy and the strong dollar, are increasing the cost of electronic equipment in regions like Western Europe and Japan. This, in turn, is lowering sales while encouraging buyers to shift to low-cost equipment in these markets. The added fear that PC sales have slowed didn’t help either.

Andrew Norwood, research vice president at Gartner, said, "Not only did the year start badly, but we are not seeing the typical ramp up in sales of semiconductors in many areas of the market in anticipation of the holiday season .As a result, sales are not going to recover enough in the second half to halt an annual decline in semiconductor revenue for 2015."

In fact, over the past year, slowing growth and rising costs led to major deals in the chip industry. According to a report by Dealogic inOctober, so far in 2015, chip companies have spent $100.6 billion on mergers and acquisitions, already exceeding the $37.7 billion for deals announced in 2014.

Significant acquisitions include Avago (AVGO - Analyst Report)–Broadcom (BRCM - Analyst Report), Intel (INTC - Analyst Report)–Altera and Freescale–NXP Semiconductors (NXPI - Snapshot Report).

Avago-Broadcom: The merger of the two highly acquisitive companies created the largest producer of diversified wired and wireless communications chips. The combined entity was valued at $37 billion and is expected to generate revenues worth $15 billion a year in addition to cost synergies. The new company lists Apple (AAPL - Analyst Report) and Samsung as major customers.

Intel-Altera: Altera is intended to protect Intel’s turf in the data center market and support its growth in IoT through new product categories. In the data center space, Altera’s FPGAs can serve as accelerators to speed up processing, and counter challenges from Qualcomm, which is attempting to make headway with ARM designs. Altera will continue to make chips based on ARM designs, perhaps to make up for the deficit for now. Intel expects the $16.7 billion deal to generate cost synergies and better utilization rates.

Freescale-NXP Semiconductors:The $40 billion merger is a play for strength in the fast-growing automotive and IoT markets. The new company will be particularly strong in auto chips, making it the leading supplier into that market, replacing Renesas. The prospects in advanced driver assistance systems (ADAS) and their limited offerings in the segment, should increase the focus on these. In IoT, the companies will target growth prospects in microcontrollers.

The Underdogs

While the semiconductor industry might appear to be doomed for the moment, there is always light at the end of the tunnel for diamonds are found in the rough.

Here are 5 semiconductor stocks that we believe have the potential to drive the tech sector even further. All of them have a Buy rank and an attractive Zacks Industry Rank.

A top Zacks Industry Rank signifies that more stocks within that group are likely to have witnessed upward earnings estimate revisions, implying a bullish outlook.

Texas Instruments (TXN - Analyst Report) climbed more than 9% since the earnings announcement on Oct 21. The company topped our earnings estimate by 9 cents and that for revenues by $140 million. For the fourth quarter, the company expects revenues in the range of $3.07–$3.33 billion and earnings within 64–74 cents. The mid-points of both the ranges are higher than the Zacks Consensus Estimate of $3.12 billion and 62 cents, respectively, at the time of issuing the guidance.

The Zacks Rank #1 (Strong Buy) stock has an attractive Zacks Industry Rank of 12.

Shares of Intel (INTC) moved up nearly 6% to-date post the earnings announcement on Oct 13. The world's largest chipmaker continued its winning streak by outperforming our estimates for earnings and revenues for the seventh consecutive quarter. It posted earnings per share of 64 cents on revenues of $14.47 billion that surpassed the Zacks Consensus Estimate of 59 cents and $14.23 billion, respectively. The company expects revenues in the range of $14.3–$15.3 billion for the fourth quarter, the mid-point of which is approximately in line with our current estimate.

The Zacks Rank #2 (Buy) stock also has a Zacks Industry Rank of 12.

Sporting a Zacks Rank #1 and the best Zacks Industry Rank of 0, Sigma Designs, Inc. (SIGM - Snapshot Report) designs, manufactures (using subcontractors) and markets multimedia products that are used in PCs. Through its REALmagic product line incorporating Moving Picture Experts Group (MPEG) technology, the company has become a leader in this emerging market.

Cree, Inc. (CREE - Snapshot Report) is a market-leading innovator and manufacturer of semiconductors that enhance the value of solid-state lighting, power and communications products by significantly increasing their energy performance and efficiency. Key to Cree's market advantage is its world-class material expertise in silicon carbide and gallium nitride for chips and packaged devices that can handle more power in a smaller space while producing less heat than other available technologies, materials and products. It carries a Zacks Rank #2 and a Zacks Industry Rank of 10.

With a Zacks Rank #2 and a Zacks Industry Rank of 10, Tokyo Electron Ltd. (TOELY - Snapshot Report), along with its subsidiaries, develops, manufactures, distributes, and sells semiconductor and flat panel display (FPD) production equipment.

Conclusion

While everyone loves the tech sector right now, this particular sub-sector has fallen from investors’ graces. We suggest that you don’t ignore it.

And as Warren Buffet puts it, “Be greedy, when others are fearful, and fearful when others are greedy.” It is time to be smartly greedy and look for the hidden diamonds!