The past 13 years have been exceptionally kind to growth stocks. Historically low lending rates have given fast-growing companies access to cheap capital, which they've used to hire, acquire, and innovate. Even in a rising-rate environment, lending rates remain well below historic norms.
This access to cheap capital has been especially fruitful for the semiconductor industry. Today, you can find semiconductor chips and solutions in an assortment of consumer electronic devices, automobiles, military systems, and healthcare imaging systems.
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According to a report from Fortune Business Insights, the semiconductor industry is expected to grow at a compound annual rate of 8.6% through 2028, ultimately hitting a market size of more than $803 billion. In other words, as we become more reliant on technology in our everyday lives, there exists an opportunity for investors to take advantage of growing demand for semiconductor chips and solutions.
Of course, not every semiconductor stock can be a winner. Below are two chip stocks that can be bought hand over fist, as well as one semiconductor stock investors would be best off avoiding like the plague.
Semiconductor stock No. 1 to buy hand over fist: Broadcom
Among the more than five dozen publicly traded companies in the chip industry, I'd anoint Broadcom (AVGO 0.61%) as the most no-brainer buy of the bunch.
Sporting a mega-cap valuation, Broadcom has shown it can consistently outperform the broader market. Since chipmakers are cyclical companies, and periods of economic expansion last considerably longer than recessions, buying Broadcom stock and sitting on your hands for years has long been a moneymaking strategy.
Broadcom has two core growth drivers that can sustain high-single-digit to low-double-digit growth through at least the midpoint of the decade.
First and foremost, the company is a clear beneficiary of the 5G wireless revolution. It's been about a decade since wireless download speeds were meaningfully improved. With telecom companies spending billions to upgrade their infrastructure to 5G, demand for 5G-capable devices has soared. Broadcom derives a majority of its revenue by providing 5G wireless chips and accessories for next-generation smartphones. The longer the smartphone replacement cycle takes, the better a position Broadcom will find itself in.
Aside from smartphones, investors should be eyeing the company's ancillary opportunities. In particular, Broadcom makes access and connectivity chips used in data centers. With businesses shifting their data online and into the cloud at an accelerated rate in the wake of the pandemic, data center demand shows no sign of slowing down.
According to Broadcom CEO Hock Tan, the company is booking production all the way out into 2023, and started doing so months ago. That bodes exceptionally well for the company's pricing power.
And if you need one more good reason to buy Broadcom stock, consider this: The company's quarterly dividend has increased by more than 5,700% since late 2010. Broadcom strikes the perfect balance of growth, value, and income for patient investors.
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Semiconductor stock No. 2 to buy hand over fist: Qorvo
For you value investors, Qorvo (QRVO 0.04%) is the second semiconductor stock to buy hand over fist.
Qorvo and Broadcom actually have a lot in common, even though the former is primarily focused on radio-frequency solutions. The common thread they share is that most of their revenue is dependent on smartphones. Thus, the steady rollout of 5G wireless infrastructure should allow Qorvo to benefit from increased demand through 2025, at minimum.
What allows Qorvo to stand out is the company's tightknit relationship with Apple (AAPL 1.27%). Based on data from Counterpoint, Apple's smartphones accounted for 56% of all U.S. sales in the fourth quarter of 2021, up from "just" a 40% share in the third quarter of 2020 (prior to the introduction of 5G iPhones). Qorvo notes that 30% of its sales in 2021 came from Apple, with each new iPhone offering an opportunity to expand its reach and further cement itself as a core supplier in the United States' most-popular smartphone.
However, Qorvo's alternative revenue channels have the potential to grow even faster than its cyclically driven smartphone-dependent segment. For instance, Qorvo provides advanced antennas on next-generation vehicles that allow them to connect to the cloud. It also supplies intelligent motor controllers for scooters and battery-powered bicycles. These are relatively small sales channels that can sustain double-digit sales growth.
Taking into account Qorvo's ties to Apple and the growth potential associated with 5G stocks, it makes absolutely no sense that a company capable of sustained high single-digit sales growth is commanding a forward-year (2023) price-to-earnings multiple of less than nine. If Broadcom represents the steady rock of the chip industry, Qorvo is most certainly the screaming bargain of the group.
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The semiconductor stock to avoid: nLIGHT
On the other side of the coin is small-cap semiconductor and fiber laser stock nLIGHT (LASR 0.46%), which I'd suggest investors avoid like the plague.
If you're scratching your head and wondering what in the heck the applications are for semiconductor and fiber lasers, you're probably not alone. The company generates its revenue from three categories: Aerospace and defense, industrial, and microfabrication. Within aerospace and defense, semiconductor lasers are used in space communications and missile guidance, to name a few applications.
As for the industrial space, they're used in welding and cutting metal. And when it comes to microfabrication, lasers are used in everything from semiconductor equipment to surgical systems in the medical industry.
Superficially speaking, the market for semiconductor and fiber lasers should continue to grow over time. As technological needs shift to high-powered laser solutions, nLIGHT has a pathway to succeed.
However, there are also red flags investors should be aware of. For instance, historically low lending rates should have led to an acceleration of sales growth from nLIGHT. What we're seeing is the opposite. Despite averaging 23% annual sales growth between 2016 and 2021, Wall Street is only looking for sales growth of 8% and 16% in 2022 and 2023, respectively.
Why the slowdown? Blame it on higher shipping costs and the company's shift in geographic focus. Last year, revenue from China fell by 33%, including a 60% tumble during the fourth quarter. While sales growth outside of China has been strong, it's impossible to sweep a 60% quarterly sales decline from a previously important revenue driver under the rug. In second-quarter 2020, China accounted for 41% of total sales.
As you might have guessed, the pandemic and this geographic shift have also hurt the company's bottom line. Three months ago, the consensus among the seven Wall Street analysts covering nLIGHT was that it would earn $0.43 in 2022. Those estimates have since fallen to a loss of $0.01 per share. The earnings forecast for next year has also been nearly cut in half.
In an industry where the vast majority of companies are valued at forward-year price-to-earnings ratios below 20, it makes little sense to pay 39 times next year's earnings for a semiconductor stock that's in the midst of a transition and has seen its top-line growth decelerate.
