PonyWang
Thesis
Semiconductor stocks got hammered in 2022, but the history of past cycles suggests 2023 could look significantly better. Most of the current criticism of semiconductor stocks is related to short-term demand issues and geopolitical concerns. While some semi companies have structural issues, many of them are executing well and are positioned to take advantage of long-term secular tailwinds. Investors are getting an opportunity to buy these companies at a significant discount, provided they have a multi-year time horizon and understand the geopolitical risks involved.
Holdings of the SOXX
The SOXX ETF (NASDAQ:SOXX) is a great way to gain exposure across the semiconductor industry. SOXX has a dividend yield of 1.08% and an expense ratio of 0.4%.
SOXX ETF Information (iShares)
Here are the top 20 holdings of the iShares Semiconductor ETF:
Weight of the Top 20 Holdings in the SOXX ETF (iShares)
Their holdings encompass many different segments of the semiconductor supply chain, which is good for those who want broad exposure to the semiconductor industry.
Companies Executing Well
Several companies held by the ETF have been executing flawlessly on their strategic plans despite near-term demand issues. These companies are ignoring the noise and focusing on their strategic plans, and this is what drives success over the long-term.
Advanced Micro Devices (AMD): AMD is gaining market share in the datacenter market and are continuing to realize synergies from their Xilinx and Pensando acquisitions. Their advancements in modular chip design allow them to be flexible and design whatever computing solutions are required by their customers.
QUALCOMM (QCOM): While handset demand is showing signs of slowing in some of Qualcomm’s end markets, the company is rapidly diversifying into the IOT and auto markets, and are decreasing their reliance on licensing revenue.
NVIDIA (NVDA): Nvidia continues to be the king of the GPU market, and they are involved in significant development in AI. Their datacenter segment continues to grow nicely despite a glut of consumer GPU parts caused by crypto miners selling GPUs they no longer need.
Broadcom (AVGO): Broadcom has continued to diversify their business more into software revenue. If their acquisition of VMware (VMW) gets approved, it would strengthen their strategic position in software and further diversify their business.
KLA Corporation (KLAC): KLA is taking advantage of the need to build more chip manufacturing capacity around the globe. Unlike some semiconductor equipment manufacturers, KLA has a firm grip on their chosen markets of process control, process-enabling, yield management, and metrology. This allows them to better weather cycles and take advantage of the continually increasing complexity of the semiconductor manufacturing process.
ASML Holding N.V. (ASML): ASML is the only company that produces machines capable of EUV lithography. This type of lithography allows for the manufacturing of leading edge chips with the highest level of transistor density. High levels of transistor density led to lower power consumption and greater efficiency without giving up yield. All semiconductor fabs want these machines and as long as ASML maintains their competitive advantage they will continue to sell every machine they can make.
Taiwan Semiconductor Manufacturing Company (TSM): TSM is working to perfect their 3nm process node and is continually investing in new capacity. Recently they announced they were going to increase their investment in the US and build a second fab in Arizona. This will help them better serve their US customers and continue to take advantage of the growing demand for their manufacturing services.
ON Semiconductor (ON): On Semi is instrumental in the production of automotive chips, especially those contained in electric vehicles. As EV market share increases and chip density per car increases, ON Semi has a unique opportunity to capitalize on their strengths and become an important part of the automotive industry.
Secular Tailwinds
The SOXX ETF gives investors exposure to many secular tailwinds such as the continued adoption of AI and cloud computing, the ever increasing chip content in products, and an increase in the total computing power required by the global economy. These are some of the reasons that McKinsey forecasts a 7% CAGR over the next decade.
Estimated CAGR of the Semiconductor Industry (McKinsey and Company)
Of this growth they estimate that “About 70 percent of growth is predicted to be driven by just three industries: automotive, computation and data storage, and wireless.” The SOXX ETF holds many companies that are directly involved in these end markets.
Automotive: The companies that are best poised to take advantage of growth in the automotive end market are On Semi, Qualcomm, NXP Semiconductors (NXPI) and to a lesser extent Nvidia.
Computation and Data Storage: AMD and Nvidia are well positioned to satisfy the desire of cloud hyperscalers to implement the solution with the lowest total cost of ownership. The shift to prioritizing more energy efficient chips is a tailwind for both ASML and TSM, as they both dominate their respective fields.
Wireless: Qualcomm is the leading player in wireless and will continue to expand their reach in the handset and IOT end markets. Analog Devices (ADI) and Broadcom also benefit from growth in this end market.
These trends aren’t going away, and investors can capitalize by buying the long-term growth story while pessimism is running high and investors shun the sector.
Price Action
Over the past year, SOXX has meaningfully underperformed the SPY.
But when we zoom out to a five-year time horizon, it’s clear who the winner has been.
A large part of the semiconductor industry is cyclical in nature, but what’s important is how much total growth happens over the duration of the cycle. The long-term growth of the semiconductor industry is far above that of the market, and this will likely continue for the next decade. This should in turn cause the SOXX to continue to outperform the S&P 500 over the next five years and beyond.
Valuation
The valuation of many semi companies got overextended during 2020 and 2021 and have since come back to earth. The SOXX itself has a PE of 16.45, which is significantly below the S&P 500’s PE of 18.83.
Fund Characteristics of SOXX (iShares)
This is despite the semiconductor industry having a higher long-term growth rate than the market. The companies held by SOXX also have the benefit of being on the leading edge of technological innovation, or at least are the beneficiaries of technological innovation. The same can’t be said about the average company in the S&P 500, or even most companies in the index.
We believe that this valuation marks a good time to buy SOXX and that investors can consider this a good addition to further diversify their portfolio. SOXX is a good way for value focused investors to gain exposure to tech and innovation while avoiding highly speculative companies and those valued on price to sales or non-GAAP earnings.
Risks
The semiconductor industry is exposed to more risks than many sectors of the economy, and these risks can be complicated. Investors should do thorough research and fully understand the risk involved before making an investment. Here are some of the risks and threats to the semiconductor industry in 2023 and beyond.
Demand Issues
The reason many market opportunities exist is because there is a risk factor that counterbalances the reward. While there are many risks to semis, the most immediate one is a decline in semi demand. Gartner forecasts for “worldwide semiconductor revenue growth to decline 3.6% in 2023”. Their reason for this call is because they believe “Rapid deterioration in the global economy and weakening consumer demand will negatively impact the semiconductor market in 2023”. While this is certainly true, the market is a forward looking mechanism. Once the downturn can be quantified, investors will begin to look ahead to the next cycle. Many companies have been discounted on fears of revenue deterioration, and if the trough isn’t as deep as feared, the names will subsequently be re-rated higher. The major near-term risk is that if the trough is worse than anticipated, we would not have reached a bottom in the sector and these stocks would likely have further to fall.
Geopolitical Concerns
A long-term risk to the semiconductor bull case is geopolitical tensions. Recently, the US took actions to restrict China’s access to semiconductor technology. The immediate impact of this is the impediment of many US firms’ ability to sell products in China. The long-term impact of these actions are an increase in the likelihood that China increases their hostile posturing against Taiwan in some form. Any disruption in the semiconductor supply chain would be devastating for the global economy, and especially semi companies. The geopolitical risk is very real and is something investors should think carefully about before making an investment in SOXX or any other semiconductor-exposed ETF or company.
Structurally Challenged Companies
Some companies held by SOXX are facing structural challenges. Most notable of these companies is Intel (INTC) and Micron Technology (MU). Intel has massive challenges in their manufacturing division, and the design division isn’t doing much better. Micron is involved in the memory market, which is heavily commoditized and prone to massive boom/bust cycles. A risk is that more semiconductor companies develop structural challenges. This would damage the secular bull case for owning the sector.
Key Takeaways
Now could end up being an advantageous time to start investing in the semiconductor industry, and SOXX is a great ETF for this purpose. Investors are getting an opportunity to buy the ETF at a significant discount, provided they have a multi-year time horizon. The geopolitical risks are no joke. That being said, the risk/reward appears favorable if an escalation fails to materialize and the economy begins to pick up steam.
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PonyWang
Thesis
Semiconductor stocks got hammered in 2022, but the history of past cycles suggests 2023 could look significantly better. Most of the current criticism of semiconductor stocks is related to short-term demand issues and geopolitical concerns. While some semi companies have structural issues, many of them are executing well and are positioned to take advantage of long-term secular tailwinds. Investors are getting an opportunity to buy these companies at a significant discount, provided they have a multi-year time horizon and understand the geopolitical risks involved.
Holdings of the SOXX
The SOXX ETF (NASDAQ:SOXX) is a great way to gain exposure across the semiconductor industry. SOXX has a dividend yield of 1.08% and an expense ratio of 0.4%.
SOXX ETF Information (iShares)
Here are the top 20 holdings of the iShares Semiconductor ETF:
Weight of the Top 20 Holdings in the SOXX ETF (iShares)
Their holdings encompass many different segments of the semiconductor supply chain, which is good for those who want broad exposure to the semiconductor industry.
Companies Executing Well
Several companies held by the ETF have been executing flawlessly on their strategic plans despite near-term demand issues. These companies are ignoring the noise and focusing on their strategic plans, and this is what drives success over the long-term.
Advanced Micro Devices (AMD): AMD is gaining market share in the datacenter market and are continuing to realize synergies from their Xilinx and Pensando acquisitions. Their advancements in modular chip design allow them to be flexible and design whatever computing solutions are required by their customers.
QUALCOMM (QCOM): While handset demand is showing signs of slowing in some of Qualcomm’s end markets, the company is rapidly diversifying into the IOT and auto markets, and are decreasing their reliance on licensing revenue.
NVIDIA (NVDA): Nvidia continues to be the king of the GPU market, and they are involved in significant development in AI. Their datacenter segment continues to grow nicely despite a glut of consumer GPU parts caused by crypto miners selling GPUs they no longer need.
Broadcom (AVGO): Broadcom has continued to diversify their business more into software revenue. If their acquisition of VMware (VMW) gets approved, it would strengthen their strategic position in software and further diversify their business.
KLA Corporation (KLAC): KLA is taking advantage of the need to build more chip manufacturing capacity around the globe. Unlike some semiconductor equipment manufacturers, KLA has a firm grip on their chosen markets of process control, process-enabling, yield management, and metrology. This allows them to better weather cycles and take advantage of the continually increasing complexity of the semiconductor manufacturing process.
ASML Holding N.V. (ASML): ASML is the only company that produces machines capable of EUV lithography. This type of lithography allows for the manufacturing of leading edge chips with the highest level of transistor density. High levels of transistor density led to lower power consumption and greater efficiency without giving up yield. All semiconductor fabs want these machines and as long as ASML maintains their competitive advantage they will continue to sell every machine they can make.
Taiwan Semiconductor Manufacturing Company (TSM): TSM is working to perfect their 3nm process node and is continually investing in new capacity. Recently they announced they were going to increase their investment in the US and build a second fab in Arizona. This will help them better serve their US customers and continue to take advantage of the growing demand for their manufacturing services.
ON Semiconductor (ON): On Semi is instrumental in the production of automotive chips, especially those contained in electric vehicles. As EV market share increases and chip density per car increases, ON Semi has a unique opportunity to capitalize on their strengths and become an important part of the automotive industry.
Secular Tailwinds
The SOXX ETF gives investors exposure to many secular tailwinds such as the continued adoption of AI and cloud computing, the ever increasing chip content in products, and an increase in the total computing power required by the global economy. These are some of the reasons that McKinsey forecasts a 7% CAGR over the next decade.
Estimated CAGR of the Semiconductor Industry (McKinsey and Company)
Of this growth they estimate that “About 70 percent of growth is predicted to be driven by just three industries: automotive, computation and data storage, and wireless.” The SOXX ETF holds many companies that are directly involved in these end markets.
Automotive: The companies that are best poised to take advantage of growth in the automotive end market are On Semi, Qualcomm, NXP Semiconductors (NXPI) and to a lesser extent Nvidia.
Computation and Data Storage: AMD and Nvidia are well positioned to satisfy the desire of cloud hyperscalers to implement the solution with the lowest total cost of ownership. The shift to prioritizing more energy efficient chips is a tailwind for both ASML and TSM, as they both dominate their respective fields.
Wireless: Qualcomm is the leading player in wireless and will continue to expand their reach in the handset and IOT end markets. Analog Devices (ADI) and Broadcom also benefit from growth in this end market.
These trends aren’t going away, and investors can capitalize by buying the long-term growth story while pessimism is running high and investors shun the sector.
Price Action
Over the past year, SOXX has meaningfully underperformed the SPY.
But when we zoom out to a five-year time horizon, it’s clear who the winner has been.
A large part of the semiconductor industry is cyclical in nature, but what’s important is how much total growth happens over the duration of the cycle. The long-term growth of the semiconductor industry is far above that of the market, and this will likely continue for the next decade. This should in turn cause the SOXX to continue to outperform the S&P 500 over the next five years and beyond.
Valuation
The valuation of many semi companies got overextended during 2020 and 2021 and have since come back to earth. The SOXX itself has a PE of 16.45, which is significantly below the S&P 500’s PE of 18.83.
Fund Characteristics of SOXX (iShares)
This is despite the semiconductor industry having a higher long-term growth rate than the market. The companies held by SOXX also have the benefit of being on the leading edge of technological innovation, or at least are the beneficiaries of technological innovation. The same can’t be said about the average company in the S&P 500, or even most companies in the index.
We believe that this valuation marks a good time to buy SOXX and that investors can consider this a good addition to further diversify their portfolio. SOXX is a good way for value focused investors to gain exposure to tech and innovation while avoiding highly speculative companies and those valued on price to sales or non-GAAP earnings.
Risks
The semiconductor industry is exposed to more risks than many sectors of the economy, and these risks can be complicated. Investors should do thorough research and fully understand the risk involved before making an investment. Here are some of the risks and threats to the semiconductor industry in 2023 and beyond.
Demand Issues
The reason many market opportunities exist is because there is a risk factor that counterbalances the reward. While there are many risks to semis, the most immediate one is a decline in semi demand. Gartner forecasts for “worldwide semiconductor revenue growth to decline 3.6% in 2023”. Their reason for this call is because they believe “Rapid deterioration in the global economy and weakening consumer demand will negatively impact the semiconductor market in 2023”. While this is certainly true, the market is a forward looking mechanism. Once the downturn can be quantified, investors will begin to look ahead to the next cycle. Many companies have been discounted on fears of revenue deterioration, and if the trough isn’t as deep as feared, the names will subsequently be re-rated higher. The major near-term risk is that if the trough is worse than anticipated, we would not have reached a bottom in the sector and these stocks would likely have further to fall.
Geopolitical Concerns
A long-term risk to the semiconductor bull case is geopolitical tensions. Recently, the US took actions to restrict China’s access to semiconductor technology. The immediate impact of this is the impediment of many US firms’ ability to sell products in China. The long-term impact of these actions are an increase in the likelihood that China increases their hostile posturing against Taiwan in some form. Any disruption in the semiconductor supply chain would be devastating for the global economy, and especially semi companies. The geopolitical risk is very real and is something investors should think carefully about before making an investment in SOXX or any other semiconductor-exposed ETF or company.
Structurally Challenged Companies
Some companies held by SOXX are facing structural challenges. Most notable of these companies is Intel (INTC) and Micron Technology (MU). Intel has massive challenges in their manufacturing division, and the design division isn’t doing much better. Micron is involved in the memory market, which is heavily commoditized and prone to massive boom/bust cycles. A risk is that more semiconductor companies develop structural challenges. This would damage the secular bull case for owning the sector.
Key Takeaways
Now could end up being an advantageous time to start investing in the semiconductor industry, and SOXX is a great ETF for this purpose. Investors are getting an opportunity to buy the ETF at a significant discount, provided they have a multi-year time horizon. The geopolitical risks are no joke. That being said, the risk/reward appears favorable if an escalation fails to materialize and the economy begins to pick up steam.
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