The global chip shortage started in 2018 and 2019 as escalating trade conflicts disrupted semiconductor supply chains, then worsened in 2020 as the pandemic exacerbated those disruptions. Many top chipmakers and analysts expect the ongoing crisis to last through 2023.
That shortage is generating tailwinds and headwinds for certain companies, but it can be tough for investors to tune out the noise and separate the winners from the losers. Let's examine five main aspects of the chip shortage -- and how they could affect certain sectors and stocks.
Image source: Getty Images.
1. Understand the secular tailwinds
Even if the trade war and pandemic didn't happen, the market's demand for chips would still be elevated today. New 5G devices, gaming consoles, connected and driverless cars, and Internet of Things (IoT) gadgets all require increasing numbers of more advanced chips. Data centers are also upgrading their servers to deal with the surging usage of cloud, machine learning, and artificial intelligence (AI) services.
However, the pandemic also accelerated sales of stay-at-home consumer electronics such as PCs and gaming consoles, while disrupting the available supply of chips. Those unexpected twists made it even tougher for chipmakers to keep up with the market's insatiable appetite for new chips.
2. Understand the geopolitical tensions
The tech war between the U.S. and China is causing headaches for many chipmakers. For example, Taiwan Semiconductor Manufacturing Company (TSM 2.79%), the world's top contract chipmaker, was forced to stop accepting orders from Huawei after the U.S. blacklisted the Chinese tech giant. U.S. chipmakers like Skyworks Solutions and Micron Technology were also forced to cut ties with Huawei.
That decoupling caused China to aggressively subsidize its domestic chipmakers, while its regulators threatened to delay big deals -- such as Nvidia's (NVDA 3.17%) planned purchase of Arm -- that benefit American chipmakers. Meanwhile, the U.S. has granted subsidies to TSMC to build new plants in Arizona, and will likely subsidize Intel's (INTC 5.00%) plans to expand its domestic foundries.
3. Understand the different types of chipmakers
Investors shouldn't touch any chip stocks until they understand the differences between integrated device manufacturers (IDMs), fabless chipmakers, chip designers, and third-party foundries.
IDMs design, manufacture, and sell their own chips. Intel, Skyworks, and Texas Instruments are all IDMs -- but Intel manufactures smaller and more complex chips than those other two chipmakers.
Fabless chipmakers design their own chips but outsource the production to third-party foundries. These chipmakers -- which include Nvidia, Advanced Micro Devices, and Qualcomm -- adopt this model because it's become too expensive to mass produce advanced chips on their own.
Chip designers license their designs to other chipmakers instead of manufacturing any chips. The industry's most important chip designer is arguably Arm Holdings, which provides designs for most of the world's mobile chips. That's why Nvidia's planned takeover of Arm is so controversial.
Lastly, third-party foundries do the heavy lifting for fabless chipmakers. TSMC and Samsung are the world's two most advanced contract chipmakers -- but Intel is trying to catch up with aggressive investments in its third-party foundry services. These leading foundries represent bottlenecks in the semiconductor market, and the chip shortage won't be resolved until they expand their capacity.
Image source: Getty Images.
4. Evaluate the revenue growth vs. the rising costs
The global chip shortage seems to make TSMC a great investment since it's a linchpin of the market, but investors should realize it needs to significantly boost its capex to expand its capacity while maintaining its lead in the "process race" of creating smaller and more advanced chips.
TSMC plans to boost its capex from $17.2 billion in 2020 to approximately $30 billion this year, then collectively spend roughly $100 billion on its expansion over the next three years. Investors should weigh those rising costs against its projected revenue growth to see if the stock is worth buying. They should also view Intel and Samsung (which isn't available on U.S. exchanges) through the same lens.
Investors should also see where all that spending is going. One of those top beneficiaries is ASML Holding (ASML 3.62%), the Dutch semiconductor equipment maker that has monopolized the entire market for high-end EUV (extreme ultraviolet) systems -- which TSMC, Samsung, and Intel all need to manufacture their smallest and most advanced chips.
Therefore, it might make more sense to invest in ASML, another linchpin of the global semiconductor market, instead of other chipmakers as a long-term play on the ongoing chip shortage.
5. Understand which companies are affected the most
In addition to treading carefully with chipmakers and equipment makers during the shortage, investors should understand how the current bottlenecks could affect consumer-facing companies like Apple (AAPL 0.39%), Sony, and Nintendo. Apple expects the chip shortage to impact its iPhone shipments this year, while Sony and Nintendo expect those headwinds to throttle their shipments of PS5 and Switch consoles, respectively. The shortage is also disrupting the production of new vehicles.
Most of these companies should recover since there's plenty of pent-up demand for their products, but investors shouldn't ignore the near-term headwinds. Investors who want to profit from the shortage over the next two years should dive deeper into the semiconductor sector instead.
