Try asking a group of advisors this question: If you saw an opportunity to get clients into stocks with reasonable P/Es (from low prices and sustained good earnings), low risk (indicated by fundamentals) and strong projected growth (signaled by unflagging global demand), would you jump at the chance?
Most would probably answer “yes.”
Yet, the fallen prices of semiconductor stocks, whose (otherwise) robust condition the above question describes, indicate that the advisors’ answer might not be completely honest.
Many advisors may be letting the new bear market and fears of near-term recession fears deter them from taking advantage of low semi valuations. Contrary to the philosophy of strategic opportunism they may espouse, they’re staying away.
Semiconductor companies are no exception to the NASDAQ’s spring swoon—a trend that has given rise to what I call TARP (tech at a reasonable price). In the case of semiconductors, valuations are startlingly low, considering highly positive projections from analysts and sanguine market outlooks.
Yet some advisors tar all tech stocks with the same brush, regardless of merit. In doing so, they may be part of a market that’s throwing the beautiful baby of chip stocks out with bathwater that includes high P/E companies with little or no profit.
Doubting Thomases
To doubting Thomases, it doesn’t matter that demand for chips is insatiable, stemming from their role in all things digital and many things not—a scenario that could be likened to making bricks for a world where everyone's building houses made only of bricks.
The tape-obsessed would say, well, the overall market is down and may go lower, disproportionately punishing all tech stocks—the good with the bad and the ugly--so let’s wait and see. But trying to call the bottom, of course, is a fool’s errand. And regardless, the more practical question is: What is this industry’s short- and long-term potential, relative to current price levels?
Seldom can this question be answered for any industry as unequivocally as it can now for semiconductors, as abundant indicators project reliable near- and long-term growth. Yet the market’s characteristic obsession with immediate gratification leaves it unimpressed.
Analysts’ projections are supported by extensive market research. To wit:
• Overall, the semiconductor industry remains on track to deliver another healthy year of growth as the super cycle that began in 2020 continues, a report from McKinsey & Co. concludes.
• For 2022, growth of about 10% is projected–to a record $600 billion-plus—and by 2030, to more than $1 trillion, reports Deloitte, characterizing this growth as “robust.”
• These expectations/projections are linked with extremely high confidence in the industry—at an all-time high, KPMG reports—regarding performance this year. About 95% of semiconductor company leaders forecast their company's revenue to grow this year—68% of them at 11% or more. Further, 88% expect to expand their capital spending and workforces this year.
• About 70% of the industry’s growth this year will be driven by just three user industries: automotive, computation and data storage/wireless.
Even if global economic activity declines significantly, semiconductors’ growing role as essential building blocks in technical and non-technical products will likely continue like the energizer bunny.
Demand comes from a world where chips are spreading from uses in electronic devices to a curiously essential role in toasters, overly complicated toilets, neck massagers, washing machines that play jingles and all manner of appliances connected to IoT (the internet of things)—a driver of the mounting data tsunami. If your fridge is to order your groceries and your Tesla is to text you that a bad actor is getting too close to it in the parking lot, this wireless traffic must be routed through data centers that are using more and more chips.
Fallen Shares
Despite high growth projections for the industry (which many recession-obsessed advisors may be glumly discounting), semi share prices—as reflected by VanEck Semiconductor ETF SMH—have fallen by more than one-third (to around $216) since November ($319). After declining through the spring, this fund fell off a cliff in mid-June, plummeting in one week from $245 to $214--its level in December 2020—before declining even further.
Over the first half of this year, shares of companies with some of the industry’s lower risk levels (by fundamentals) have hemorrhaged substantially, losing as much as 40% of their value.
Average analyst projections for 10 companies that made it through our risk screens contrast sharply with the prevailing sentiments of the Fed-obsessed market.
Leading this pack in mid-June for projected average annual five-year EPS growth was Broadcom (AVGO), at more than 24% (with a whopping tech dividend yield of more than 3%); followed by Microchip Technology Corp. (MCHP), more than 23%; NXP Semiconductors NV (NXPI), 19.5%; and KLA Corp. (KLAC), 16%.
KLA led the group in trailing 12-month return on equity, with 93%, followed by Lam Research (LRCX), 75%; Texas Instruments (TXN), 61%; and Applied Materials (AMAT), 55%.
Most of this relatively low-risk group—which also includes Teradyne, Analog Devices and Skyworks Solutions—has 12-month trailing P/Es ranging from the mid-teens to the mid-20s.
One reason analysts are particularly bullish on Broadcom is its pending $61 billion acquisition of VMware. Supporting its four-out-of-five-star BUY rating of Broadcom in a June report, CRFA wrote: “We like AVGO’s attractive valuation and potential FCF/EPS, with the pending VMware deal to support $8.5B in targeted EBITDA contribution (combined annual FCF +$20B). The greater software exposure (about 49% sales post-deal versus 25% currently) also improves visibility and offers higher-margin potential while diversifying from semiconductors.”
Healthy Baby
Thus, in the aggregate, the 24 or so analysts providing ratings on stocks in this group expect the discarded semiconductor baby to not only live, but to thrive. In the short term, this infant is plenty strong enough to withstand headwinds including supply-dunning lockdowns in China and likely slowing economies in the U.S. and abroad.
Lockdowns will almost certainly pass in the next year or two, and American dependence on Chinese manufacturing will decline with planned re-shoring of U.S. company plants to American soil. A prime example lies in Intel’s plans for a $20 billion complex for fabricating chips in Licking County, Ohio—part of an envisioned investment of $100 billion.
The chip industry is poised for growth over the likely bumpy short term and will then probably muster a sustained upward trend for the next few years.
Driving sales will be service and product vendors and their consumers, who would live in cardboard boxes before giving up their phone data plans. Many of these same people are beginning to view EV purchases as money-saving moves as they resume their pre-pandemic commutes amid soaring gasoline prices.
America is a highly digital nation driving the global digital revolution, in which chips play a role as critical as that of steam engines or oil in previous industrial revolutions.
Tech stocks led the S&P 500 into its current bear state, but chips are hardly in hibernation. This industry will likely be in the vanguard of tech industries leading the overall market to recovery, consistent with tech’s history as a market driver.
Dave Sheaff Gilreath, CFP, is a founding partner and CIO of Innovative Portfolios, an institutional money management firm, and of Sheaff Brock Investment Advisors. Based in Indianapolis, the firms manage about $1.4 billion.