The semiconductor industry is constantly evolving to make chips smaller and more powerful. But in today's interconnected world, the demand for chips has expanded beyond consumer electronics and into cars, industrial machinery, and virtually every sector of the economy. The shift from mechanical processes to automation requires more chips. And that makes semiconductor stocks worth a look amid the broader stock market sell-off.
An inexpensive way to make money with microchips
Scott Levine (Texas Instruments): If you're like many other investors, you've suffered a few sleepless nights recently thanks to the fear of an extended market downturn. While some may be running to fortify their portfolios with gold and other safe-haven investments, others are turning to the stocks of dividend machines like semiconductor manufacturer Texas Instruments -- a stock that currently offers an attractive 3% forward yield.
A cursory look at the stock's valuation may lead some to recoil at its price-to-sales ratio of 7.6, in light of the 2.5 P/S multiple of the S&P 500. Dig slightly below the surface, however, and you'll find that this is a discount compared to TI's five-year average sales multiple of 8.3 -- but don't conclude that it's a bargain now on that valuation alone.
Let's consider how shares are valued in terms of cash flow. Currently, shares are valued at 16 times operating cash flow, representing a discount to their five-year average cash flow multiple of 19.3. Furthermore, shares of Texas Instruments are trading at 17.7 times trailing earnings -- a notable discount to its five-year average P/E of 24.2.
Turning to the dividend, income investors will surely embrace management's commitment to rewarding shareholders. For 18 consecutive years -- from 2004 to 2021 -- Texas Instruments has raised its dividend at a compound annual growth rate of 25%. While there's no guarantee that the company will increase the payout at the same rate in the years ahead, the dividend growth indicates management's dedication to shareholders. Yet management hasn't sacrificed the company's financial health to please shareholders with its rising dividend: Over the past 10 years, Texas Instruments has averaged a conservative payout ratio of 53.3%.
A high-yield blue chip dividend stock poised for a turnaround
Daniel Foelber (Intel): Intel stock has lacked luster in recent years. An absence of innovation caused the company to lose market share to Advanced Micro Devices and other competitors. In many ways, the stock deserved to fall. But looking ahead, buying shares now could make for an excellent turnaround play.
Intel made headlines in January when it announced a $20 billion investment in two chip factories in Ohio. However, it then announced in late June that its megaproject could be delayed based on the status of the CHIPS for America Act, a bill that is meant to bolster domestic chip production to create jobs and wean the U.S. off of chip imports.
Regardless of the timing of the project, the semiconductor industry has multidecade tailwinds. The growing need for domestic production is yet another green light for Intel to enter expansion mode.
With a price-to-earnings ratio of just 6.4 and a current dividend yield of 3.9%, Intel looks like a great source of passive income, while also providing upside potential if it can turn its business around.
A cyclical maker of chipmaking equipment
Lee Samaha (Applied Materials): The semiconductor industry is highly cyclical; it always has been, and it always will be. Сustomers cut production plans and stop ordering chips at the first sign of a slowdown. Similarly, as soon as the budding shoots of recovery appear, customers start picking up phones and placing chip orders. That goes for chip manufacturers and also for companies that make semiconductor manufacturing equipment, like Applied Materials.
That's something you can see clearly in the chart below. Revenue oscillates wildly but continues in a general uptrend, interspersed with dramatic falls during recessionary periods. However, note that the company generates good amounts of free cash flow that easily covers its growing dividend:
Applied Materials' key customers include Samsung, Intel, and Taiwan Semiconductor. And if the recent warning from another chip maker, Micron Technology, is anything to go by, then a significant slowdown is coming. Applied Materials will feel it in the coming quarters, too -- so don't be surprised if the company suffers some bad news soon.
That said, if you believe this will just be another temporary trough in a long-term uptrend, it makes sense to start looking into investing in the sector. After all, the need for more and more chips in intelligent devices isn't going away over the long term. Moreover, this time around, semiconductor stocks like Applied Materials will pay a dividend while you wait for the next upturn.