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Why Chip Companies Are Important to the Future of Tech

By Leo Sun - Mar 12, 2021 at 8:30AM

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The world's feverish demand for chips won't cool off anytime soon.

Over the past 12 months, the Philadelphia Semiconductor Index rallied about 90% as global demand for chips surged through the pandemic. Stay-at-home trends boosted sales of new PCs, data centers installed more chips to keep pace with the surging usage of cloud and AI services, and new technologies -- including driverless cars, automated factories, and 5G networks and devices -- gobbled up more chips.

That demand propelled the price of many leading chip stocks, including Qualcomm, Advanced Micro Devices (AMD 1.63%), and NVIDIA (NVDA 5.08%), to historic highs. Taiwan's Taiwan Semiconductor Manufacturing (TSM 1.91%), the world's largest contract chipmaker, also benefited from those surging orders.

An illustration of a semiconductor.

Image source: Getty Images.

That demand won't cool off anytime soon. The global semiconductor market could still expand at a compound annual growth rate of 10% from 2021 to 2026, according to research firm EMR, as companies across a wide range of industries purchase more chips.

Let's see why chip companies are so important to the future of tech, and why everyone should own at least a few stocks from this growing sector.

Secular growth and content share gains

Electronic devices will need an increasing number of chips as they become more advanced. A simple illustration of this can be found in Skyworks Solutions' (SWKS 1.82%) latest investor presentation, in which it highlights its content share gains in 2G, 3G, 4G, and 5G devices.

Skyworks claims each 2G device only contained $3 in front-end chips. That figure rose to $8 in 3G devices, $18 in 4G devices, and $25 in 5G devices. We can see similar content share gains in connected cars, industrial machines, and data centers.

An android with a shattered head.

Image source: Getty Images.

New growth markets -- such as wearables, home automation devices, driverless cars, augmented reality, and AI-powered services -- will all require a growing number of chips.

That's why the PC market faced a chip shortage over the past two years after Intel struggled to manufacture its newest CPUs, and why the auto market currently faces a shortage of chips for newer cars.

That supply crunch will likely replace the old chipmaking cycle, which had clearly defined peaks and troughs, with a new "super cycle" of fresh growth in which an abundance of new technologies beyond PCs, data centers, and mobile devices spark constant demand for new chips.

Bottlenecks and flashpoints

That supercycle is already forcing TSMC, which manufactures chips for most of the world's fabless chipmakers, to boost its capex as much as 63% this year to expand its capacity. South Korea's chipmakers, including TSMC's top rival Samsung, are also expected to boost their average capex by more than 20% this year.

A lot of that capex will flow to ASML (ASML 0.30%), the Dutch semiconductor equipment maker that supplies TSMC and Samsung with EUV (extreme ultraviolet) lithography machines for etching circuit patterns onto wafers. ASML holds a near-monopoly in lithography machines, and its EUV machines are required to produce the world's smallest 5nm and 7nm chips.

Companies like TSMC, Samsung, and ASML all represent bottlenecks in the market. They're also flashpoints in the ongoing tech war between the U.S. and China, since neither country's fabless chipmakers can produce the world's most advanced chips without these companies.

That's why the Trump administration barred TSMC from making chips for Chinese chipmakers like Huawei and SMIC last year, and why ASML only sold its older lithography machines -- not its newest EUV systems for 5nm and 7nm chips -- to SMIC in a recent deal.

Plenty of potential picks for value or growth

Semiconductor stocks might seem like higher-growth plays, but there are plenty of potential picks for both value and growth-oriented investors.

Texas Instruments (TXN 1.28%), which produces analog and embedded chips for a wide range of industries, is still a solid pick for conservative investors. It's raised its dividend annually for 17 straight years, grown its free cash flow per share at an average rate of 12% annually between 2004 and 2020, and reduced its share count by 42% during the same period with consistent buybacks.

Meanwhile, NVIDIA and AMD, which are both expected to generate double-digit revenue and earnings growth this year, are great picks for growth-oriented investors who want to profit from the growth of the high-end gaming and data center markets.

As for TSMC and ASML, the two gatekeepers of the semiconductor industry still provide an attractive balance of value, growth, and dividends. Simply put, there's no reason for investors to avoid semiconductor stocks altogether -- especially when they're the building blocks of so many future technologies.

 

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Stocks Mentioned

Texas Instruments Incorporated Stock Quote
Texas Instruments Incorporated
TXN
$170.01 (1.28%) $2.15
Skyworks Solutions, Inc. Stock Quote
Skyworks Solutions, Inc.
SWKS
$101.70 (1.82%) $1.82
QUALCOMM Incorporated Stock Quote
QUALCOMM Incorporated
QCOM
$131.23 (2.10%) $2.70
ASML Holding N.V. Stock Quote
ASML Holding N.V.
ASML
$548.08 (0.30%) $1.65
Taiwan Semiconductor Manufacturing Company Limited Stock Quote
Taiwan Semiconductor Manufacturing Company Limited
TSM
$90.41 (1.91%) $1.69
NVIDIA Corporation Stock Quote
NVIDIA Corporation
NVDA
$169.75 (5.08%) $8.21
Advanced Micro Devices, Inc. Stock Quote
Advanced Micro Devices, Inc.
AMD
$92.65 (1.63%) $1.49

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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