Companies in the Semiconductor – General industry are at the forefront of the ongoing technological revolution based on HPC, AI, automated driving, IoT and so on. These semiconductors also enable the cloud to function and help analyze the data into actionable insights that can be used by companies to operate more efficiently.
If anything, the pandemic has strengthened the conviction that these technological changes are required and inevitable, because it is these technology platforms that enabled us to function when it was unsafe for us to go to work or meet people. Even with the opening up of the economy, the race to digitization, cloud, AI, etc. is expected to continue at an accelerated rate, continuing to drive strong demand for semiconductors.
NVIDIA has pioneered and built a whole lot of this cutting-edge technology, so it remains a top recommendation in this group. Texas Instruments is more of a defensive play, but a very steady performer as well.
About the Industry
The companies grouped under the Semiconductor – General category produce a broad range of semiconductor devices, both integrated and discrete, like microprocessors, graphics processors, embedded processors, chipsets, motherboards, wireless and wired connectivity products, DLPs and analog, serving multiple end markets. The industry includes companies like NVIDIA, Texas Instruments, Intel and STMicroelectronics.
According to the latest sales statistics from the Semiconductor Industry Association (SIA), semiconductor sales in the first quarter of 2021 grew 17.8% year over year, with China growing 25.6%, Asia Pacific/All Other 17.6%, Japan 13.0%, the Americas 9.2% and Europe 8.7%. The SIA/WSTS haven’t revised their semiconductor sales growth forecast of 8.4% in 2021.
Here are the major themes shaping the industry -
Being on the building-block side of technology, the industry stands to benefit from the proliferation of the Internet and the growing digitization of our lives, irrespective of the direction we move in the future. So, if the change in the way we are doing things during the pandemic attains even partial perpetuation, it will have a profound impact on the semiconductor industry. Smartphones and PCs are still the biggest consumers of chips. IDC expects smartphones to grow 5.5% in 2021 (previous 4.4%), helped by easier comps and 5G push from suppliers. It expects 3.6% CAGR from 2020-2025. 5G will be 40% of total volume this year reaching 69% share in 2025. Gartner expects 11.4% growth in 2021, up from previous estimate of 3.3% growth, with 5G accounting for 35%. and The PC market grew 32% (47% including Chromebooks) in the first quarter, helped by easy comps. While the chip shortage and easing of pandemic-related restrictions could impact shipments, PC demand is expected to remain strong. But other segments are gaining in importance. AI for instance should also grow (PWC expects a 50% CAGR between 2019 and 2022, albeit off a relatively small base of $6 billion). In IoT, which is still evolving, ResearchAndMarkets has a longer-term forecast: 31.4% CAGR between 2020 and 2027. Automotive electronics is another area of evolving needs and strong growth potential (Grand View Research estimates a 9% CAGR in 2020-2027, driven by safety systems, ADAS, hybrids, energy storage). Automation and robotics, with increasing adoption across industrial operations, are other areas of growth. So there is plenty of scope for reallocation of semiconductor capacity that will take place over the next few years.
Because of the growth potential in emerging markets, regulatory (and/or political) issues in China and the U.S., can play an increasingly important role. The government’s strong stance against prime trading partner China has cast a shadow over the space. Semiconductor companies in particular stand to benefit from a truce between the U.S. and China as the Chinese government’s drive to build its own industry requires plenty of collaborations with leading semiconductor players. Moreover, commercial sales to China would help fund costly R&D in the U.S. The government is more concerned about IP protection and is trying to delay as far as possible, China’s own technological maturity. This is particularly negative for the industry because semiconductors typically go into manufacturing devices, the largest chunk of which is made in China.
Because end devices have to be priced lower to reach more people, the pressure on companies to bring down cost remains. But although companies will find it advantageous to move operations to places where labor may be cheaper or the proximity to manufacturing facilities can lower transportation and other cost, the government’s focus on boosting domestic production will impact decisions. Industry consolidation should continue however, as larger players add expertise through acquisitions. There’s also likely to be close collaboration with device makers, facilitating quicker consumption and better inventory management.
Zacks Industry Rank Indicates Caution May Be In Order
The Zacks Semiconductor-General Industry is a stock group within the broader Zacks Computer and Technology Sector. It carries a Zacks Industry Rank #211, which places it in the bottom 17% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates uncertain near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
An industry’s positioning in the bottom 50% of the Zacks-ranked industries is normally because the earnings outlook for the constituent companies in aggregate is not encouraging. In this case, while the 2021 estimates remain on an upward trend from pre-pandemic levels, the 2022 estimate remains below this level, indicating a correction in demand or cost increases.
Looking at the aggregate earnings estimate revisions, it appears that analysts are positive about the industry’s growth prospects. As a result, the aggregate earnings estimate for 2021 has grown 10.0% over the past year while the estimate for 2021 is down 3.2%.
Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.
Industry Leads on Stock Market Performance
Tracking the performance of the Zacks Semiconductor – General Industry over the past year shows that the industry has mostly traded between the broader Zacks Computer and Technology Sector (on the higher side) and the S&P 500 index (on the lower side), although it has moved higher or lower than both at times.
The industry gained 43.2% over the past year compared to the 53.2% gain of the broader sector and the 46.5% gain of the S&P 500 index.
One-Year Price Performance
Industry’s Current Valuation
On the basis of forward 12-month price-to-earnings (P/E) ratio, which is a commonly used multiple for valuing semiconductor companies, we see that the industry is currently trading at 23.69X, which is between its median value and highest level achieved in the past year, and above the S&P 500’s 22.27X and the sector’s forward-12-month P/E of 27.18X.
Over the last five years, the industry has traded as high as 23.94X, as low as 19.42X and at the median of 22.58X, as the chart below shows.
Forward 12 Month Price-to-Earnings (P/E) Ratio
2 Stocks Worth Considering
The industry doesn’t have a whole lot of buy-ranked stocks. In fact NVIDIA and TXN are the only ones. Texas Instruments is a good stock, albeit a defensive one given that it continues to deliver the goods quarter upon quarter and year after year. It rarely has a bad quarter and rarely an exceptional one. Since it’s a steady performer, it’s also included here.
NVIDIA Corp. (NVDA): NVIDIA Corporation is the worldwide leader in visual computing technologies and the inventor of the graphic processing unit, or GPU. As the GPU’s parallel processing capabilities were increasingly found to be even more effective for complex computing applications, the company saw its addressable market expand.
Today, it is these chips that drive the high performance computations in not only gaming but also in a variety of other applications like artificial intelligence and virtual reality. Considering the scope of application and the fact that these are all at the cutting edge of technology, the company should see sustained growth for years to come.
After acquiring Mellanox for $7 billion earlier this year, the company has cemented its competitive moat against Intel in AI and HPC, the two most happening areas with the greatest growth potential. So it is now even better positioned for growth.
Fourth quarter results topped the Zacks Consensus Estimate by 10.7%, after which the current year EPS estimate of this Zacks Rank #2 (Buy) stock increased 1.4% from $13.37 to $13.56.
The shares are up 78.6% over the past year.
Price and Consensus: NVDA
Texas Instruments (TXN): TI is an original equipment manufacturer of analog, mixed signal and digital signal processing (DSP) integrated circuits. The company serves diverse end markets where demand typically balances out to generate the steady results it is known for.
Its manufacturing strategy involves the use of mature processes of its own where it maintains high utilization rates. This is supplemented with external foundries when demand increases sufficiently. So it’s a very well-run business.
First quarter results topped the Zacks Consensus Estimate by 19.9%, after which the current year EPS estimate of this Zacks Rank #2 (Buy) stock increased 8.7% from $6.77 to $7.36.
The shares of the company are up 61.7% over the past year.
Price and Consensus: TXN
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