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.