By James Rogers
Despite potential for further downside, semiconductor stocks could rebound significantly over the next couple of years, according to Columbia Threadneedle Senior Equity Analyst Dave Egan.
Semi stocks have struggled this year, mirroring concerns about the broader economy. There has also been pessimism about the chip sector following mixed forecasts in the second quarter and worries that customers may have overbought amid supply-chain issues.
Speaking during a media roundtable on Tuesday, Egan pointed to contraction in valuation multiples in the two indices. “For both, the price-to-earnings multiples are just about are five to 10% above the trough that we saw in 2018,” he said.
“Part of the lower multiples is because of higher interest rates,” he said. “But it’s also because people are anticipating that estimates are going to be coming down.”
A typical semiconductor downturn compared to current Wall Street estimates would suggest that sales estimates are about 15% too high, according to Egan. However, the analyst noted the cyclical nature of the semiconductor market.
“This is a cyclical sector — a downturn would be followed by a recovery and then with that recovery in the fundamentals, you would get a recovery in valuation multiples back to about normal,” he said. “What you could see in the near term is further downside, but you essentially eventually get a bottoming process, and then over the next couple of years, the SOX index would rebound and can more or less double from here, which is pretty attractive.”
“That would be, though, the average for semis,” he added.
Egan pointed to growing adoption of chips across a growing number of markets, such as data centers, autos, industrial uses and healthcare. Set against this backdrop, semiconductor sales are expected to double between 2020 and 2030 to reach around $1 trillion, according to Columbia Threadneedle’s data.
The analyst also talked about how the “quality” of a company or an industry can change structurally, offering a trifecta of better sales, better margins, and, often, better valuation multiples. “This has been a driver of ‘multi-bagger’ returns for us on a number of stocks,” he said. “We think that that is an actual source of alpha for us.”
“Stocks that we have invested in for this may surprise … these include Nvidia Corp. /zigman2/quotes/200467500/composite NVDA +4.27% , Marvell Technology Inc. /zigman2/quotes/200053236/composite MRVL +3.07% , Broadcom Inc. /zigman2/quotes/200646538/composite AVGO +2.35% , ON Semiconductor Corp. /zigman2/quotes/202641012/composite ON +7.23% , which is still going through transition, and the list goes on,” Egan added. “The semi industry has been full of these types of opportunities.”