For over a year, semiconductors have been one of the leading industries pushing this bull market higher. This is evident from the sector’s outperformance in addition to impressive earnings growth by many companies in the industry. Since the March 2020 low, the VanEck Vectors Semiconductors ETF (SMH) is up 163%, while the S&P 500 is up 94% over the same timeframe.
Even more interesting is that many of the leading companies in the industry have seen their price-to-earnings ratios decline over the past year, as earnings growth has outpaced stock price appreciation. Notably, this is not the case for the S&P 500 which has seen significant multiple expansion.
Like a lot of tech and growth stocks, semiconductors have underperformed since mid-February. Unlike many of those stocks, semiconductor stocks have continued to post strong earnings reports and look poised to start outperforming once again. 3 semiconductor stocks that investors should consider buying are Applied Materials (AMAT), Broadcom (AVGO), and Texas Instruments (TXN).
What’s Unique About This Cycle
Typically, semiconductors are a cyclically sensitive industry, as spending on tech fluctuates with economic growth rates. However, this changed during the pandemic as tech spending exploded as companies and people had to adapt to the ‘new normal. Many people’s stimulus payments also went to items such as computers, phones, TVs, etc.
So, while demand increased, semiconductor companies faced the same challenges as many industries when it came to production. Companies had to grapple with meeting health requirements as well as supply chain disruptions. Most companies operate on a just-in-time inventory basis. While this strategy maximizes profits and minimizes waste during normal periods, it exacerbated production issues as key components would be unavailable.
As a result, we are seeing the effects in many industries that are reliant on semiconductors such as autos. Another factor is that semiconductors are now found in all types of items that weren’t considered high-tech in the past like refrigerators, fire alarms, and washing machines which are having an impact on supply and demand.
And, it’s not surprising that the world is facing a supply crunch. Many fabricators are investing in new capacity which will take many years to come online. Recently, Commerce Secretary Gina Raimondo said that “For the next year or so, this will be a daily challenge.”
3 Stocks to Buy
Therefore, I believe that investors should continue to invest in the industry as the supply crunch will result in increased pricing power. Over the last few months, valuations have started to improve, while a handful of stocks have started to break out to new highs. 3 of the best-positioned semiconductor stocks are Applied Materials (AMAT), Broadcom (AVGO), and Texas Instruments (TXN).
Applied Materials (AMAT)
AMAT provides manufacturing equipment, services, and software to the semiconductor, display, and related industries, and it operates through three segments: Semiconductor Systems, Applied Global Services, and Display and Adjacent Markets. AMAT is one of the companies that is benefitting from the chip shortage and is also investing in new capacity.
The company’s strong momentum is evident in its recent earnings report which showed a 41% increase in revenue to $5.6 billion and a 76% increase in net income to $1.33 billion. Margins have also been trending higher.
These types of results tend to lead to analysts hiking their forecasts. For Q3, they are expecting EPS and revenue to increase by 45% and 29%. The company also has a streak of beating expectations for 4 straight quarters.
AMAT’s POWR Ratings reflect this promising outlook. The stock has an overall B rating, which equates to Buy in our POWR Ratings system. This isn’t surprising given that AMAT is one of the few semiconductor manufacturers during a global shortage. It also isn’t surprising that AMAT has a B grade for Quality given its strong management team and track record of topping earnings expectations.
To see more of AMAT’s POWR Ratings, click here.
AVGO operates through two segments: infrastructure software solutions and semiconductors. Its chips are found in all sorts of products including iPhones, computers, and networking equipment. Thus, the company has benefitted from the iPhone’s massive sales as well as increased spending with the 5G revolution.
Its infrastructure software is used to manage data centers which have also seen substantial growth with cloud computing. Semiconductors account for 75% of revenue but infrastructure software is growing faster and comes with bigger margins. Some analysts want to see the company split up into two parts to better monetize value.
Given its exposure to two, different parts of tech which are growing at double-digit rates, its recent string of strong earnings reports is not surprised. In Q1, revenue increased by 14% with EPS growing by 25%. Given that its stock price has been range-bound, AVGO’s price to earnings ratio dropped from 55 to 43. For Q2, analysts project a 25% increase in EPS and 14% increase in revenue. Over the last year, operating margins have increased from 14% to 20%.
AVGO’s POWR Ratings reflect this outlook. The company has an overall A rating, which translates to Strong Buy in our proprietary rating system. The POWR Ratings assess stocks by 118 different factors, each with its own weighting. A-rated stocks have posted an average annual performance of 30.7% which handily beats the S&P 500’s 7.1% average annual gain over the same period.
Note that AVGO is one of the few handpicked stocks currently in the Reitmeister Total Return portfolio. Learn more here.
Texas Instruments (TXN)
TXN operates through two segments—Analog and Embedded Processing. Analog sells power products to manage power requirements. The Embedded Processing segment offers connected microcontrollers, digital signal processors (DSPs), and applications processors.
TXN has been a major beneficiary of the current industry conditions in the semiconductor market. This is evident from its accelerating revenue growth. Over the last four quarters, it went from -12% to increase by 28% in Q1.
Analysts have also been hiking consensus EPS estimates by 44% and 21% over the past 12 months which is a good indication that its business is gaining momentum. TXN produces its own chips, so it’s been less negatively affected than other companies. However, chip sales could increase further if auto production does return to normal in the coming months.
Analysts expect TXN’s EPS to improve by 21% and revenue to increase by 23% in the next quarter. The company has a streak of topping analysts’ estimates for 5 straight quarters. Over the last year, TXN is up 43%. However, it’s been consolidating over the past couple of months in a tight range. This circumstance favors an upside breakout in companies with strong and improving fundamentals.
This strong outlook is reflected in its POWR Ratings. The stock has a B overall rating, which equates to Buy in our proprietary rating system. B-rated stocks have an average annual performance of 17.3%.
TXN is ranked #33 of 98 stocks in the B-rated Semiconductor & Wireless Chip industry. The industry has a B rating which is consistent with recent positive developments and the continued chip shortage over the next 12 to 18 months.
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This article was written by Jaimini Desai, Chief Growth Strategist for StockNews.com. Jaimini has been dialed into the hottest trends in investing:
- Electric Vehicles
- Internet of Things
- Cloud Computing
- And Much More
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AMAT shares fell $0.08 (-0.06%) in after-hours trading Friday. Year-to-date, AMAT has gained 59.12%, versus a 13.86% rise in the benchmark S&P 500 index during the same period.
About the Author: Jaimini Desai
Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of the POWR Growth and POWR Stocks Under $10 newsletters. Learn more about Jaimini’s background, along with links to his most recent articles. More...
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