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Semiconductor-General Stock Outlook: Moderately Positive Prospects

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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 Intel, NVIDIA, Texas Instruments and STMicroelectronics.

According to the Semiconductor Industry Association (SIA), the U.S. is the largest producer of semiconductors with 45% market share. The SIA’s August report showed that June sales slid 0.3% from May because of continued macroeconomic pressures. North America stood out from the rest with 30% year-on-year growth in June. While the second quarter was roughly flat with the first, the SIA is concerned about the rest of the year, citing continued uncertainties.

Three major themes shaping the industry are as follows-

  • 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 becomes more permanent, it will have a profound impact on the semiconductor industry that may necessitate the reallocation of resources to areas of greater demand. Smartphones (IDC expects 2.3% decline due to first-half pandemic-driven pressures, Gartner expects a 13.7% decline with 5G demand impacted by availability, cost, a weaker jobs market and limited infrastructure build across geographies except China) and PCs (Gartner expects 10.5% decline overall with business continuity considerations and the work from home trend driving mix shift to business notebooks and ultramobiles) are still the biggest consumers of chips. AI should 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 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 now 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 would have required plenty of collaborations with leading semiconductor players. Moreover, commercial sales to China would have helped 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 will remain. So 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. Industry consolidation is also likely to continue 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 Moderate Returns

The Zacks Semiconductor-General Industry is a stock group within the broader Zacks Computer and Technology Sector. It carries a Zacks Industry Rank #33, which places it in the top 13% 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 bright 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.

The industry’s positioning in the top 50% of the Zacks-ranked industries is because of the encouraging earnings outlook for the constituent companies in aggregate. 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 2020 has grown 4.0% over the past year while the estimate for 2021 has grown 0.2%.

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 led both the broader Zacks Computer and Technology Sector and the S&P 500 index through most of the past year.

The industry gained 54.8% over the past year compared to the 36.6% gain of broader sector and the 16.7% 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 21.22X, its highest level over the past year but below the S&P 500’s 22.86X and the sector’s forward-12-month P/E of 26.32X.

Over the last five years, the industry has traded as high as 21.22X, as low as 12.86X and at the median of 16.37X, as the chart below shows.

Forward 12 Month Price-to-Earnings (P/E) Ratio

Bottom Line

Any change in the way we do things will have a profound impact on the industry and may require reallocation of resources (for the long term). Work-related segments should be more resilient in the near term, which is the reason for relative optimism about the industry. But this has made valuation unattractive, especially given increased uncertainties. So here are some solid names that we may opt for when the valuation is more conducive:

Texas Instruments (TXN - Free Report) : The Zacks Rank #1 (Buy) stock has appreciated 12.1% over the past year. The Zacks Consensus Estimate for the current-year EPS has grown 25% in the last 30 days.

Price and Consensus: TXN

NVIDIA Corp (NVDA - Free Report) : The Zacks Rank #2 (Buy) stock has gained 192.1% over the past year. The Zacks Consensus Estimate for the current-year EPS remains unchanged in the last 30 days.

Price and Consensus: NVDA

STMicroelectronics N.V. (STM - Free Report) : The Zacks Rank #2 (Buy) stock has jumped 63.2% over the past year. The Zacks Consensus Estimate for the current-year EPS has increased 18.1% in the last 30 days.

Price and Consensus: STM

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