The stock market has gotten off to a rough start in 2022. The S&P 500 is down 7.3% and the Nasdaq is off 11.8%. Growth stocks -- and tech stocks in particular -- have underperformed. And it's not just the trendy pandemic tech stocks, like Zoom or Peloton, that have taken a hit. The VanEck Vectors Semiconductor ETF (SMH -0.07%) has pulled back 13.9% in 2022 after bagging a 41.9% return in 2021. With its beta of 1.23, the ETF shows that the semiconductor sector tends to run hot and cold -- beating the broad market during bull markets but also falling behind in bear markets.
One company that has followed this trend is Nova Ltd. (NVMI -1.50%). The Israeli-based semiconductor equipment company founded in 1993 has lost 23.2% this year, after a stellar 2021, where they finished the year with a 107.5% gain. Nova provides metrology (i.e., measurement) solutions for chipmakers such as Taiwan Semiconductor (TSM -1.05%) and Intel (INTC 0.80%).
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Almost everything has a chip in it these days
You've probably heard about how chip shortages are impacting the automotive industry. But it might surprise you to learn that everything from toothbrushes to washing machines relies on semiconductors.
Gartner Research noted that global semiconductor revenue grew 25.1% in 2021 and surpassed $500 billion for the first time in history. 5G wireless, automotive, and cloud server demand outpaced supply and drove up prices, leading to shortages in the overall market. As a result, chipmakers need to scale up production, but they also need to invest in the next generation of faster, more powerful chips.
And those chips will need to be small -- very small. That's where Nova comes in. Its measurement technology will benefit from two trends: the current high demand for chips and the evergreen desire to make smaller, more complex chips.
Small chips equal fast chips
In a nutshell, the smaller you can make a semiconductor, the faster it can process complex tasks. However, making ever-smaller chips is -- shall we say -- complicated.
Today's semiconductors operate on the scale of nanometers. That's one billionth of a meter. For a sense of scale, a human hair is roughly 80,000 to 100,000 nanometers; a strand of DNA is approximately 2.5 nanometers across. Nova helps chipmakers produce memory units that operate at the scale of 5 nanometers or less.
At this nearly atomic level of smallness, precision is critical. Nova provides the hardware and software that can measure semiconductors' chemical, material, and physical properties. Think of it as the microscopic equivalent of "measure twice, cut once." Nova's products help ensure that the manufacturing process ends with speedy and reliable chips.
High growth, but can it continue?
As demand for semiconductors has soared, Nova's sales have as well. Based on Nova's Q3 2021 earnings report, revenues grew 43.9% year over year -- far outpacing the S&P average of 13.5%. Earnings have jumped 103.5% year over year, and operating margins have grown from 15.2% in 2016 to 26.8% over the last 12 months.
Nova expects to report full-year 2021 revenues on Feb. 24. Analysts estimate Nova should grow revenues 15% in 2022. However, Nova has a history of upside surprises on both the top and bottom lines. Looking ahead, the company has guided above $400 million -- representing more than 50% year-over-year growth. New production facilities in Japan and Arizona for its largest customer -- Taiwan Semiconductor -- should come online in the second half of 2022 and drive further revenue growth for Nova.
Is Nova's growth worth the risk?
The ultimate question is whether Nova can maintain its high rate of growth in both revenues (>50% year over year) and earnings (100% year over year). The Q4 results coming on Feb. 24 should show how Nova is managing increased transportation and supply costs. Despite supply chain challenges, Nova expects operating margins of 30% for 2021 -- higher than management's goal of 26% to 29%.
With a P/E ratio of 24.9, Nova is similarly valued with respect to both the sector and broader market averages. So, if you're an investor who wants to add a small-cap (Nova's market cap is $3 billion) growth stock -- and you're willing to endure the volatility typical in the semiconductor sector -- Nova might be for you.
