Semiconductor chips act as both the “brains” and the infrastructure of the information economy. Most of the growth industries of today rely on processors, memory chips and integrated circuits. Without these components, there would be no cloud computing revolution, no artificial intelligence, and no software industry.
In this article we give you a basic overview of the semiconductor industry and how to go about investing in the industry. We also highlight the most important companies in the industry.
- What are semiconductors
- Semiconductor industry
- Investing in semiconductor companies
- 10 Largest semiconductor stocks
- Semiconductor equipment and design companies
- Semiconductor ETFs
- Global chip shortage and what it means for investors
What are semiconductors
A semiconductor is a material that can be both an electrical conductor and an insulator. Their conductive properties can be changed by manipulating the material, or exposing them to electrical fields, heat, or light. In the world of technology, the term semiconductor chip is used to refer to semiconductor wafers with electric circuits & transistors on them. Silicon is typically used as the semiconductive material, although the search is on to find other materials.
Semiconductor materials and chips are used to make processors, memory chips and other components. They are used to store data, process data using logic, and to transmit data. They are also used for sensors, displays and solar cells. Semiconductor chips are the physical building blocks that enable computing and the digital economy.
While semiconductor companies are often referred to as chipmakers, most do not actually manufacture their own chips. Historically chipmakers did manufacture their own products, but over the past three or four decades the industry has become fragmented. The reason is that semiconductor fabrication is extremely difficult. It’s usually easier to outsource manufacturing to companies with proven capabilities.
Fabrication is done in factories known as foundries. Today, just five companies own the foundries responsible for over 90% of chip fabrication. Companies that design and sell chips while outsourcing the fabrication are known as fabless semiconductor producers. Some companies simply design and then license their intellectual property to manufacturers. Finally, there are companies that provide equipment, software, and services to semiconductor producers. Most of the industry is involved in a race to make chips of ever decreasing size. Smaller chips draw less power and allow more components and functionality in each device.
The smallest chips currently being produced are 5nm chips. The 5nm (nanometer) term is actually just a marketing term, but theoretically refers to the size of the nodes that can be created. Intel and Samsung are developing 3nm chips, and IBM recently announced it is developing a 2nm chip.
Investing in semiconductor companies
The semiconductor industry is cyclical and it’s the most cyclical industry in the technology sector. Semiconductor stocks are affected by business cycles like other cyclical stocks in the financial and consumer discretionary sectors. However, the industry is probably more like the basic materials and energy sectors, where both supply and demand are cyclical.
Demand for chips often depends on sales of products that are brand new – which makes forecasting difficult. Supply is affected by the time it takes for companies to respond to changes in demand. These dynamics can lead to dramatic cycles for the companies and their stock prices. While the industry is cyclical, chip stocks can also be growth stocks. A company’s revenue can increase rapidly and high barriers to entry lead to very wide margins.
When it comes to stock picking in the industry, you need to consider the industry as whole and how well individual companies are positioned in growing markets. Valuation metrics like PE ratios can be useful to determine the relative valuation of a stock to the industry. You then need to consider what that company’s sales are likely to look like three to five years from now.
10 Largest semiconductor stocks
There are a lot of excellent semiconductor stocks and it’s not possible to cover them all. So, we will mention ten of the largest and most notable companies in the industry. For reference, we will compare returns to the Philadelphia Semiconductor Index. This is the benchmark index for the industry. The index has returned 358% over the last five years and 72% in the past year.
- Taiwan Semiconductor Manufacturing Company (NYSE: TSM) – TSMC is a semiconductor foundry company that manufactures chips for most of the other chip makers. The company was founded in 1987 by Morris Chang, a former Texas instruments executive. TSMC now has numerous fabs (fabrication facilities) in Taiwan and a few other countries. The company accounts for around 55% of the world’s chip fabrication, and most electronic products in the world now contain components built by TSMC. It is the world’s 11th most valuable company with a market cap of $540 billion. TSMC’s stock price has matched the performance of the semiconductor index over the past five years but has accelerated in the last 12 months.
- Nvidia Corporation (Nasdaq: NVDA) – Nvidia has been one of the most popular semiconductor stocks of the last decade because of the way it is positioned to benefit from several technology megatrends. The company pioneered the use of GPUs (graphics processing unit) in graphics cards for the gaming industry. Since then, these cards have become integral to artificial intelligence, visualization, data centers and mining cryptocurrencies. GPUs have been essential to the advances in artificial intelligence of the past few years. Nvidia has been one of the best multibaggers for investors over the last few years. Its stock price has risen 14-fold in five years. This growth hasn’t been based on speculation as revenue has grown 4-fold and EPS have increased from 7-fold. Nvidia is trying to acquire UK based ARM Holdings but is facing resistance from regulators. ARM designs and licenses processors for smart phones and other devices. If the deal is approved, it will make Nvidia a major player in the mobile technology and internet of things industries, in addition to the industries it already supplies.
- Intel Corporation (Nasdaq: INTC) – Historically, Intel was the largest and most successful chip maker in the world. Intel pioneered several types of chips during the 1970s and 1980s, including the x86 processors that still power PCs and notebooks. Intel produces CPUs, chipsets, solid state drives and other integrated circuits. The company still fabricates its own chips unlike many of its competitors. Intel is still the largest producer of x86 chips but has lost market share to competitors like AMD in recent years. The stock price has underperformed its peers and even the S&P500 in recent years. Intel recently announced it will invest $20 billion in new fabrication facilities in the US.
- Broadcom Inc (Nasdaq: AVGO) – Broadcom produces digital and analog semiconductor products used for communication and networking technologies like Bluetooth and fiber optics. The company supplies the data center, cloud storage, networking, and infrastructure software industries. The company also recently announced a new chip that will be used to power the world’s first Wi-Fi 6E phone produced by Samsung. This is a new Wi-Fi spectrum and Broadcom is in a leading position to supply technology for phones and routers using the technology. Broadcom’s stock price has underperformed the semi-index over the past five years but is comfortably ahead of the S&P 500.
- Texas instruments Inc (Nasdaq: TXN) – Texas Instruments is one of the oldest semiconductor companies, having manufactured its first transistor in 1952. The chipmaker has been responsible for several notable innovations over the last seven decades. These include the first commercial silicon transistor, the first transistor radio, one of the original integrated circuits and the first hand-held calculator. Nowadays Texas Instruments produces a large assortment of semiconductor products and is one of the few older companies that still fabricates chips. TXN is not the most exciting of the semiconductor stocks, but it has managed to steadily grow revenue and earnings year after year. Over the last few years, the stock price has underperformed the index, but returned twice what the S&P500 has.
- Samsung Electronics (Korea Stock Exchange: 005930.KS) – Samsung is often overlooked because the stock is only listed in Korea. The company is best known for the smartphones and other electronic devices it makes. Samsung also designs and fabricates a wide range of semiconductor products for itself and for other companies. Samsung is actually a supplier of OLED displays to one of its biggest competitors, Apple. It ranks second in the world behind TSMC in terms of chip fabrication. With a market value of $490 billion, Samsung is actually the second most valuable of the semiconductor stocks. The stock price has underperformed the semiconductor industry over the past five years, but still returned twice the S&P500’s gain.
- Qualcomm (Nasdaq: QCOM) – Qualcomm is a major supplier of wireless communications products and services. Qualcomm’s Snapdragon chips are a key component of many of the smartphones available today. Qualcomm is also positioned to be a major supplier to global rollout of 5G technology. Qualcomm’s growth slowed between 2015 and 2019 which led to underperformance. However, growth has accelerated over the last 12 months.
- Micron Technology Inc (Nasdaq: MU) – Micron Technology produces memory chips and other semiconductor products. The company is a major supplier of products like RAM memory, microSD cards, and USB flash drives. Micron’s products are used in PCs, vehicles, and other consumer electronics. The company’s shares have been a solid performer over the past 5 years, beating the semi-index comfortably.
- Advanced Micro Devices Inc (Nasdaq: AMD) – AMD designs and sells CPUs, GPUs, semi-custom chips, and other semiconductors. AMD is a key supplier to the PC, graphics, cloud computing, and gaming industry and competes head-to-head with both Nvidia and Intel. Global Foundries, one of largest foundries in the world was previously part of AMD but was spun off in 2009. Since then, AMD has been a fabless chip maker. In 2020 AMD announced it would be acquiring Xilinx, the leading manufacturer of field programmable chips. Over the last few years AMD has been the top performer amongst the larger semiconductor stocks.
- Infineon Technologies AG (XETRA: IFX) – Infineon is a German semiconductor manufacturer which was originally part of Siemens AG. Today, Infineon is a one of the largest vertically integrated chip makers in the world with operations in numerous countries. Infineon is best known for supplying components to the auto industry and for its power semiconductors. The company also produces sensors, SIM cards, and chip-based security solutions. In 2019, Infineon acquired Cypress Semiconductor, another vertically integrated chip company. Other notable semiconductor stocks include NXP, Marvell, Skyworks Solutions, Analogue Devices, and ON semiconductor.
Semiconductor equipment and design companies
As is often the case, the companies that supply equipment, services and software to an industry are often a good investment too. These companies stand to benefit as long as there is investment in new chip design and fabrication capacity around the world.
- ASML Holdings (Nasdaq: ASML, Euronext: ASML) – ASML Holdings, which is based in the Netherlands manufactures equipment used to produce chips. The company is the leading supplier of photolithography devices which are used to create circuits on silicon wafers. ASML’s lithography devices are used to create features as small as 10 nanometers on nanochips. To do this an immersion lens or extreme ultraviolet light is used to produce light with a low wavelength. The stock price has outperformed the industry in the last year as the industry increases capacity. Prior to 2020, revenue was growing steadily at around 15%, but ASML also has incredibly good margins.
- Applied Materials Inc (Nasdaq: AMAT) – Applied Materials supplies the industry with manufacturing equipment, software, and services. The company also supplies equipment used to manufacture LCD screens and photovoltaic cells used to generate solar power.
- Lam Research Corporation (Nasdaq: LRCX) – Lam Research designs and manufactures semiconductor processing equipment. The company’s machines are used to create semiconductor components and wafer level packaging.
- Synopsis Inc (Nasdaq: SNPS) and Cadence Design Systems Inc (Nasdaq: CDNS) – Synopsis and Cadence both sell software and equipment used to design and test integrated circuits. Typically, new chips are designed digitally, and then prototypes are built using emulators and prototyping hardware. Testing is also done at each stage of the process. These two companies are both integral to the design and development of new chips.
- Cohu Inc (Nasdaq: Cohu) – Cohu specializes in testing semiconductors and testing the equipment used to make them. Cohu is another company that is essential to semiconductor manufacturing and its products are used throughout the industry.
The easiest way to invest in semiconductor stocks is by buying one of several semiconductor ETFs. These are the four largest funds available in the US. There are similar funds listed on other exchanges too.
- iShares PHLX Semiconductor ETF (SOXX): The largest industry ETF tracks the Philadelphia Semiconductor Index, which has 32 constituents. The index is weighted by modified market capitalization, and has an annual expense ratio of 0.46%
- VanEck Vectors Semiconductor ETF (SMH): VanEck’s chip fund is a very popular fund. This fund includes the 25 most valuable companies involved in the semiconductor industry. It is weighted by market value and investors pay 0.35% a year.
- SPDR S&P Semiconductor ETF (XSD): The State Street chip ETF is a lot smaller than the funds but includes more companies. It only holds stocks that are listed in the US and has an expense ratio of 0.35%.
- Invesco Dynamic Semiconductors ETF (PSI): The Invesco fund uses a smart beta approach to weight holdings. Factors like momentum, earnings growth, value, and management are combined to calculate weights. The fund holds 30 stocks, and the expense ratio is 0.57%.
Global chip shortage and what it means for investors
The world is currently facing a chip shortage. Chip shortages occur from time to time due to the cyclical nature of the industry, but the current shortage is particularly severe. When the pandemic began last year, automakers cancelled orders, and manufacturers switched to producing more chips for other industries. Later in the year demand from automakers returned while demand from the cloud computing industry and device manufacturers accelerated.
Wall Street analysts believe it may take as long as two years for supply to match demand. The worst affected sectors are EV stocks, and the stocks of companies that need older chips. In general, though, the effect on financial markets has been quite limited. The companies that stand to benefit from the shortage are those that fabricate chips and those that supply equipment to the industry.
Conclusion: Investing in the semiconductor industry
The semiconductor industry is unique in that most of the companies are exposed to hyper growth industries, yet they have real cash flows. This means the stocks can be valued properly, unlike companies that are still unprofitable. Most chipmakers are exposed to several different industries too – so, their revenue isn’t dependent on a single company or industry. Chip stocks should have a place in most equity portfolios – but it’s important to remember that they are cyclical, and positions may need to be managed.