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2 Stocks to Buy from the Overvalued Semiconductor Industry

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Companies in the Semiconductor – General industry are at the forefront of the ongoing technological revolution based on HPC, AI, electrified and automated driving, IoT and so forth. The semiconductors they produce enable the cloud to function and help analyze the data into actionable insights that can be used by companies to operate more efficiently. 
Despite negative forecasts from economists and market watchers alike, 2023 turned out to be stronger than initially expected. It is now clear that a recession if any will be mild. Semiconductor growth forecasts reflect the positive outlook. According to the latest data coming out of WSTS, which is also typically quoted by the Semiconductor Industry Association (SIA), global semiconductor sales dropped 8.2% in 2023.

Moreover, the SIA expects that the second half strength will continue this year leading to double-digit sales growth in 2024. Garter raised its estimates from an 11.2% decline to a 10.9% decline this year. It is also more optimistic about 2024, with current projections at 16.8% growth.

The main driver is the memory segment, where excess inventory was depressing prices in 2023 and resultant production cuts are expected to lead to shortages and therefore, price increases this year, according to DIGITIMES Research. IDC is perhaps the most optimistic, projecting 20% growth in 2024.
As far as end markets are concerned, growth in PCs and smartphones will come from new AI-enabled versions starting this year. PC growth will also be driven by the end of support for Windows 10. Commercial and enterprise deployment should also increase as a soft-landing for the economy looks increasingly likely. Driven by Internet connectivity across the developed and developing worlds and supportive technology such as sensor networks and AI adoption, the IoT market is also expected to grow steadily over the next few years.

Future Market Insights expects the industrial IoT segment alone to grow at a 12.1% CAGR between 2023 and 2033. Auto electrification, structural changes in industrial automation, data center strength, generative AI and custom chips for cloud services are expected to drive multi-year growth in semiconductors. While in the past, memory demand has been tied to PCs and servers, which is the main reason for the pandemic-related imbalance in 2023, auto and server applications will accelerate in the coming years.
The government’s target of reducing dependence on China, and onshoring projects with national security implications will shape the future of this industry.
As the outlook has turned rosier through 2023, share prices have also soared, leading to rich valuations. Despite this, companies like NVIDIA Corporation and SCREEN Holdings are worth buying.

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. It includes companies like NVIDIA, Texas Instruments, Intel and STMicroelectronics.

Major Factors Shaping the Industry

  • The long-term outlook for the industry has been robust for a while now because of its being on the building-block side of technology, which makes it crucial for the proliferation of the Internet and the ongoing digitization of every aspect of life. However, throughout this year, the short-term outlook has continued to brighten. With interest rates stabilizing and demand side factors such as inflation coming under control, we can finally focus on industry-specific issues. These too are looking up with the inventory imbalance corrected, AI-enabled end point devices coming to market this year and surging infrastructure demand stemming from the rapid adoption of generative AI. While global economies are only gradually returning to normal and geopolitical concerns remain, a very definite turn for the better is visible. 
  • There is continued strength in emerging areas like AI and machine learning, IoT and automotive. ReportLinker expects the AI chip market to grow at a CAGR of 34.5% between 2023 and 2028. The Business Research Company expects the market to grow over 38% this year and at a CAGR of over 40% between 2023 and 2028. Data-intensive applications, advancements in machine learning algorithms and increasing urbanization, as well as dynamics in the auto and financial services markets are the major drivers. Mordor Intelligence expects the IoT chip market to grow at a 14.7% CAGR between 2024 and 2029.
  • Automotive electronics is another area of evolving needs and IDC expects that ADAS growing 19.8% through 2027 (30% of auto sales by then) and infotainment growing 14.6% through 2027 (20%) will be the most important drivers.  Grand View Research estimates the auto chip market to benefit from electronic components in luxury to mass-produced cars, increasing adoption of electronic control unit (ECU) in modern vehicles and the growing focus on safety systems in vehicles. Infotainment, fuel efficiency and safety are expected to be the primary drivers as the world moves toward EVs and hybrids. Automation and robotics, with increasing adoption across industrial operations, are other areas of growth. These strong end markets will drive continued demand for semiconductor components for years to come.
  • Semiconductor supply chains are adjusting. Semiconductor supply chains have become increasingly efficient over the years. While this has brought down cost, the just-in-time model has made the supply chains relatively unreliable in case of external disruptions, as happened during the pandemic, or when China imposed its zero tolerance COVID shutdowns. This, along with other factors, such as the U.S.-imposed restraints on dealing with China is leading semiconductor companies to diversify their supply chains and reduce their dependence on the country. This is an ongoing process that will take several years. In the meantime, there is a growing concern that all the most important leading-edge chips are currently made in Taiwan, a country that China continues to threaten to annex. Since this has national security implications, there is an ongoing drive to onshore manufacturing. The $52 billion infusion from the CHIPS Act will help.

Zacks Industry Rank Indicates Moderating Prospects

The Zacks Semiconductor-General Industry is a stock group within the broader Zacks Computer and Technology Sector. It carries a Zacks Industry Rank #104, which places it in the top 41% of the 250 odd Zacks-classified industries.

The group’s Zacks Industry Rank, which is the average of the Zacks Rank of all the member stocks, indicates that near-term prospects are moderate. Our research shows that the top 50% of Zacks-ranked industries outperform the bottom 50% by a factor of 2 to 1.

An industry’s positioning in the top 50% of Zacks-ranked industries is normally because the earnings outlook for the constituent companies in aggregate is relatively strong. The opposite is true for stocks in the bottom 50% of industries. In this case, the aggregate earnings estimate for 2024 is up 83.4% from the year-ago level, while the aggregate earnings estimate for 2025 is up 58.9% from last year.                   

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.

Stock Market Performance Remains Strong

Tracking the performance of the Zacks Semiconductor – General Industry over the past year shows that the industry has traded at a premium to both the broader Zacks Computer and Technology Sector and the S&P 500 index throughout the year with a sizable bump-up in May.

The industry has gained 126.6% over the past year. The broader technology sector gained 45.5% while the S&P 500 index gained just 25.0%.

One-Year Price Performance

Zacks Investment Research
Image Source: Zacks Investment Research

Current Valuation: Rich

On the basis of forward 12-month price-to-earnings (P/E) ratio, we see that the industry is currently trading at a 35.70X multiple, which is a 2.2% discount to its median value of 36.51X over the past year. However, since the S&P 500 trades at 20.61X while the sector trades at 26.72X, the industry appears overvalued in comparison.

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

Zacks Investment Research
Image Source: Zacks Investment Research

2 Stocks to Consider

Despite the high valuation, the industry continues to look good. It will benefit all the more if there are any interest cuts this year, because that would drive money back into risky assets. Additionally, since the industry consists of several technology heavyweights that are the backbone of how computing is done these days, there is certainly reason to be optimistic for the long term. Here are a couple of stocks worth picking up today: 

NVIDIA Corporation (NVDA - Free Report) : Santa Clara, CA-based NVIDIA provides graphics, and compute and networking solutions in the U.S., Taiwan, China and other markets. Its graphics processing units (GPUs) are the most popular in the gaming segment. NVIDIA is also at the leading edge of enterprise, data center, cloud and automotive deployments today.

Generative AI is driving exponential growth in compute requirements. Because NVIDIA’s accelerated computing is versatile, energy-efficient and has low total cost of ownership, companies are rapidly transitioning to its products to train and deploy AI. NVIDIA GPUs, CPUs, networking, AI foundry services and NVIDIA AI Enterprise software are all growth engines. They are opening up opportunities and leading to broad-based growth across geographies and markets.

The automotive, financial services, healthcare and telecom verticals are particularly strong, as AI and accelerated computing are quickly becoming integral to customers' innovation road maps and competitive positioning. The data center business is the strongest right now, driven by demand for data processing, training and inference from large cloud-service providers and GPU-specialized ones, as well as from enterprise software and consumer internet companies. NVIDIA is also seeing momentum across professional visualization and automotive, ll of which together led to 126% growth in the fiscal year ended Jan 2024.

The Zacks Consensus Estimate for fiscal 2025 is up 52 cents (2.6%) in the last 30 days and up $1.01 (4.4%) for the following year.

The Zacks Rank #1 (Strong Buy) stock is up 231.9% in the past year.

Price Chart: NVDA

Zacks Investment Research
Image Source: Zacks Investment Research

SCREEN Holdings Co Ltd. (DINRF):

Headquartered in Kyoto, SCREEN Holdings develops, manufactures, sells and maintains semiconductor production equipment in Japan.

SCREEN Holdings’ earnings estimate for the year ending Mar 2024 dropped 4 cents in the last 30 days while its 2025 estimate increased 8 cents.

The shares of the Zacks Rank #2 (Buy) company have appreciated 230.7% over the past year.

Price & Consensus: DINRF

Zacks Investment Research
Image Source: Zacks Investment Research

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