By Philip van Doorn
Stocks of chip makers have run way ahead of the broader market this year, but many are still relatively cheap — and when you consider the group’s growth prospects, they may still be a long-term bargain.
The headlines in the semiconductor space have been dominated by Nvidia Corp. /zigman2/quotes/200467500/composite NVDA -3.85% , which blew out its fiscal 2021 third quarter ended Oct. 25, with sales of $4.73 billion, up 57% from a year earlier and 22% from the previous quarter. Nvidia’s shares have risen 129% this year. The company is working through the regulatory process to complete its proposed $40 billion acquisition of ARM from Softbank Group Corp. /zigman2/quotes/207303954/delayed JP:9984 -3.83% .
Nvidia’s shares now trade for 48.4 times the consensus earnings estimate for the next 12 months among analysts polled by FactSet. That is relatively high, as you can see below. Investors are willing to pay a high price for a company that dominates its main space — graphics cards for PC gaming. But even with 32 of 39 sell-side analysts polled by FactSet rating the shares “buy” or the equivalent, the consensus price target for the shares is $581.90, which is “only” 8% higher than the closing price of $537.61 on Nov. 18.
Then again, on Thursday, Credit Suisse analyst John Pitzer in a note to clients called Nividia “THE key enabler” of artificial intelligence, while calling AI ” transformative/disruptive to every industry.” His price target for the stock is $620. That is 46 times his fiscal 2023 EPS estimate of $13.50, which is “a 125% premium” to the PHLX Semiconductor Index SOX . That’s right in the stock’s historical premium range of 120% to 150%, according to the analyst.
Nvidia has been the best performer among the 30 stocks in the PHLX Semiconductor Index over the past 10 years, with a return of 4,282%. But there have been periods of painful volatility:
Nvidia may well turn out to be a fantastic investment, even from its current high price, provided you can be patient and committed for five to 10 years. For investors with shorter horizons, an ETF play on the semiconductor industry might be more appropriate, or individual stocks of cheaper chip makers.
The easiest way to invest in the semiconductor industry is by purchasing shares of the iShares PHLX Semiconductor ETF /zigman2/quotes/209255350/composite SOXX -5.19% , which holds all 30 stocks in the PHLX Semiconductor Index.
Back on Sept. 14 , SOXX was up 18.8% for 2020, compared to a year-to-date return of 6.2% for the S&P 500 Index /zigman2/quotes/210599714/realtime SPX -2.57% . At that time, even with that outperformance, SOXX was trading for 19.8 times weighted aggregate earnings estimates for the following 12 months among analysts polled by FactSet. In comparison, the forward P/E ratio for the S&P 500 was 22.1.
Fast-forward to the close on Nov. 19:
Now SOXX is up17.7% for 2020, while the S&P 500 has returned a very respectable 12.2%, underscoring how important federal stimulus efforts and the Federal Reserve’s monetary policy have been.
But SOXX still looks relatively cheap, with a forward P/E of 21.4, compared with 21.9 for the S&P 500. That isn’t a large difference, but consider this: The SOXX group’s weighted sales per share are expected to increase 20% during calendar 2020, followed by a 9.7% increase in 2021, based on analysts’ consensus estimates. For the S&P 500, revenue is expected to decline by 2.8% in 2020, followed by a 7.5% increase in 2021. Investors reward sales growth.
The following are comparisons of annual estimates and growth rates derived from the estimates for SOXX and SPX:
The biggest differences, of course, are for 2020, with SOXX expected to show a 20% increase in sales per share and an 18% increase in earnings per share, with strong increases in cash flow and free cash flow, while SPX is expected to show declines in those four areas. But the book-value growth projections also point to better long-term performance for the semiconductor group. Looking back, SOXX has returned 313% over the past five years, while SPX has returned 90%. For 10 years, SOXX has returned 655%, against a 267% return for SPX.
Going out to 2021 and 2022, the analysts expect the semiconductor group to continue increasing sales at a faster pace than the broader market. For earnings, SPX is expected to mount a broad recovery in 2021 and to continue outgrowing EPS (compared to SOXX) in 2022.
After a dim 2020, SPX is also expected to increase cash flow and free cash flow at a faster pace than the SOXX group.
Those SPX figures assume steady improvement as the coronavirus pandemic subsides, which may be difficult to imagine during these days of continuing increases to daily new COVID-19 case counts.
But the semiconductors, which have been traditionally considered a cyclical group, have broken that pattern this time around. There’s no reason to expect the trend toward more and improved remote communications technology to continue. That development, along with electric vehicles and the new connectivity for all sorts of devices, bodes well for the long term.
So the relatively low valuation for SOXX, the group’s special advantage during the pandemic and the uncertainty for the broad recovery of SPX’s sales and earnings, argue for increasing your exposure to semiconductor stocks.
Starting with the 30 stocks included in SOXX, we broadened the list to 48 by adding components of the S&P 1500 composite index in the semiconductor or electronic production equipment industry groups, with market capitalizations of at least $1 billion. (The S&P 1500 is made up of the S&P 500, the S&P 400 Mid Cap Index /zigman2/quotes/219506813/composite MID -3.41% and the S&P Small Cap 600 Index /zigman2/quotes/210599868/delayed SML -0.32% .)
Among the stocks with majority “buy” or equivalent ratings, 11 are expected to rise by double digits over the next 12 months, based on consensus price targets among analysts polled by FactSet:
Here’s a larger set of data for the group:
Scroll the table to see all the data.
If you see any stocks of interest here, the next step is to do your own research to form your own opinion about how likely a company is to remain competitive over the next decade. One way to start that is by clicking on the tickers in the first table.