2018 finished on a down note for semiconductors; as measured by the iShares PHLX Semiconductor ETF (NASDAQ: SOXX), the sector fell 8% on the year.
Some stocks in the industry are beginning to show signs of life, though, as optimism regarding a trade deal between the U.S. and China is rising. Deal or no deal, business for technology's most basic components is still strong as digital transformation is just beginning to take hold. Three names that could rebound in the new year are NVIDIA (NVDA -1.51%), Broadcom (AVGO -0.48%), and Applied Materials (AMAT -2.65%).
The GPU revolution's speed bump
Check out the latest NVIDIA earnings call transcript.
NVIDIA fared much worse than average in 2018. After running 50% higher through the autumn months, shares ended down 31% last year due to oversupply in mid-grade chipsets from the cryptocurrency bust. After the big drop, shares still aren't the cheapest out there. Trailing-12-month price to free cash flow (i.e. money left over after basic operations and capital expenditures are paid for, a more accurate measure of profitability) is at 29.2; 12-month forward price-to-earnings (P/E) estimates value the company at 21.5, compared with a forward P/E of 15.2 for the S&P 500 index.
In spite of the premium, NVIDIA looks like a compelling buy. The graphics processing unit (GPU) maker is finding new uses for its tech, and management thinks that as Moore's Law (a theory which held in practice for many years, in which the number of transistors on chips doubles every year) breaks down, its artificial intelligence-powered silicon is a compelling solution to get more computing power per square inch.
While GPUs are often associated with video games -- and rightfully so as the segment was responsible for 62% of NVIDIA's sales in the third quarter of 2018 -- they are also a fast-growing part of data-center builds, connected autos, and visual rendering for professionals. While video-game momentum may sputter this year, expect further expansion in NVIDIA's other segments. Thus, some patience may be required. Nevertheless, as GPUs grow in importance in the world of computing, NVIDIA is in a position to benefit immensely.
A lesser-known diversified chipmaker
Check out the latest Broadcom earnings call transcript.
Broadcom is a big chipmaker with a hand in everything from data centers to telecommunications to industrial equipment. Though it's already a large concern, the $20.9 billion it hauled in during the 2018 fiscal year represented an 18% increase over 2017, and adjusted earnings per share rose 30% during the year. In spite of those strong results, the company's fourth-quarter sales and profits started to slow due to global economic uncertainty, especially in China. As a result, the stock finished the year down 1%.
Nonetheless, now could be a good time to add the stock to your watchlist. Management expects revenue in 2019 to rise to $24.5 billion, another 17% increase, which should equate to even higher profits. Given those expectations, Broadcom's stock looks like a compelling value. Its 12-month trailing price to free cash flow is just 13.8, and its 12-month forward P/E is 11.5 -- implying expectations that the company will be able to grow the bottom line in the year ahead.
If that's not good enough, Broadcom also touts one of the semiconductor sector's best dividends. The current yield is a generous 4.3% as of this writing. With robust growth and a compelling payout, that makes this chip maker one of the best bets out there right now.
Helping chip makers help themselves
Check out the latest Applied Materials earnings call transcript.
Applied Materials is another diversified play on the semiconductor sector, but from a different angle than Broadcom. Rather than making chips themselves, Applied Materials designs systems and sells materials that manufacturers need in semiconductor production. Much like Broadcom, full fiscal-year 2018 results were strong, but a slowdown at year-end and a forecasted sluggish start to 2019 weighed on shares. In Applied Materials' case, that resulted in a 36% decline.
The stock could be a great deal as a result, though. Last year, sales and adjusted earnings were up 19% and 2%, respectively -- though earnings were dragged down by a $1 billion one-time tax charge at the beginning of the year. To kick off 2019, sales are expected to fall 12% year over year, pulled down primarily by a slowdown in the memory chip industry. Those headwinds are expected to subside in the back half of the year, and other growth drivers like OLED display technology and basic material sales for chips overall should continue to tick higher in the meantime.
That could mean the downturn for Applied Materials stock is just a temporary one. Its price to free cash flow is only 10.6, and its forward P/E is 9.1, implying that growth will pick back up soon. Along the way, investors get treated to a 2.4% dividend yield, making this diversified chip supplier and systems designer a value at current levels.
When stocks decline, opportunity often presents itself. Such is the case for semiconductors after a forgettable showing in 2018. Nevertheless, the growth trend is still very much in play for many chip manufacturers. With valuations much lower than a year ago and sales still headed higher, now is the time to keep an eye on the industry.