It's been an absolutely brutal year for chip stocks. The industry is down roughly 31% with just a few weeks remaining in 2022, as measured by the iShares Semiconductor ETF. That's even worse than the 29% year-to-date drop of the Nasdaq Composite Index, which most chip stocks are part of.
What started out as a run-of-the-mill sell-off turned far worse. Parts of the chip market (specifically those related to smartphone and PC sales, as well as memory chips) will be in decline through at least the first few months of 2023. Nevertheless, contrary to much of the narrative out there, most end markets for semiconductors remain healthy. Now is a great time to buy if you are a long-term investor.
Three especially cheap chip stocks to consider before the end of the year are Qualcomm (QCOM 1.41%), Applied Materials (AMAT 1.46%), and Skyworks Solutions (SWKS 1.83%). Here's why.
1. Qualcomm: An industry-defining leader trading as cheap as it's ever been
Other than perhaps Apple, no one has profited as handsomely from the advent of the smartphone and mobile computing as Qualcomm. For some three decades, the company has steadily risen from an unknown mobile communications developer to a household name. Nearly every mobile device on the planet has either a Qualcomm chip or Qualcomm-developed technology embedded in it.
The company floundered for a few years in the late 2010s, but the launch of 5G networks sent Qualcomm's sales sharply higher again over the last couple of years. A new leadership team under CEO Cristiano Amon is also working to apply the company's smartphone chips to other areas like automotive and industrial products. There's a clear path to further growth in the coming years, but Qualcomm has a hurdle to overcome first.
Data by YCharts.
That hurdle is a recent sharp drop in smartphone sales, which is expected to last into the first quarter or two of 2023. The reason? Consumer spending is taking a step back after two years of early pandemic smartphone upgrades. In tandem with that, industry supply chains are starting to ease up. In other words, more supply is coming just in time for demand to soften.
The result is an expected decline in adjusted earnings per share by as much as 30% to kick off Qualcomm's fiscal year 2023. In response, the stock has sold off to its lowest valuation ever, as measured by it price-to-earnings ratio (which sits at 10 as of this writing). Shares trade for 20 times trailing 12-month free cash flow, which is higher than price-to-earnings due to the company's recent investments to support new chip technology designs.
Qualcomm is far from finished. Once the present inventory correction is complete, this company should return to robust profitable growth. It pays a dividend and repurchases lots of stock too. With the market leaving Qualcomm for close-to-dead, now looks like an especially opportunistic time to buy.
2. Applied Materials: The top dog in chip fab equipment space
Applied Materials isn't a chipmaker itself. Rather, it makes the equipment that helps make chips. Not long after the semiconductor industry got off the ground back in the 1960s, Applied came along and started developing advanced manufacturing machines capable of progressively shrinking down the size of chips while increasing their computing power.
Today Applied is the largest chip fab equipment company around, hauling in nearly $26 billion in sales during its 2022 fiscal year. The company shook off numerous issues, including supply chain constraints, mounting economic uncertainty in China, and then new U.S. restrictions on sales to China. In the end, revenue still increased by 12% compared to 2021.
Many of these same issues remain as fiscal 2023 gets started, but Applied is still predicting year-over-year revenue growth. Profit margins are under some pressure as it works through limits to what it can sell to China, but as the year progresses this effect should dwindle away. The U.S. CHIPS Act and similar legislation in other geographies around the world set off a boom in new chip fab construction and existing fab upgrades. A key supplier to nearly all of them (including Intel and Taiwan Semiconductor Manufacturing), Applied Materials could be one of the best ways to play the coming boom in chip manufacturing capacity.
Over the last year, Applied leaned into tough times and aggressively repurchased stock, to the tune of $6.1 billion worth (or a hefty 6.7% of the current market cap). Once its profitability starts to rebound, this could have a dramatic effect on the share price. In the meantime, Applied trades for just 14 times trailing 12-month earnings (20 times free cash flow). For an industry leader that's an indispensable part of the chipmaking process, I think that's a pretty good deal.
3. Skyworks Solutions: Fast-growing in new key markets
Skyworks Solutions is another company rooted in mobile technology. For many years, its primary customer was Apple -- it supplied the iPhone maker with radio frequency semiconductors (RF), a type of analog device that converts a low-power radio signal into a high-power digital signal used by a smartphone or other computing device. Much like other companies in the mobile space, Skyworks is in the midst of and predicting a further falloff in sales through the start of calendar year 2023 as its RF and related circuits get hit by the aforementioned slowdown in consumer activity and a poor economic situation in China.
Specifically, for the first quarter of fiscal 2023 (the three months that will end in December 2022), the company expects revenue to decline about 12% from a year ago, and for adjusted earnings per share to fall about 18%.
Things could be far worse, though. Skyworks is what's known as an integrated device manufacturer (IDM), meaning it designs and manufactures chips. By contrast, fellow mobile company Qualcomm is fabless -- it designs semiconductors, but partners with foundries to handle their manufacturing. Skyworks is getting hit hard by the drop in mobile phone sales, but it has been working hard to diversify its business in recent years. It acquired the infrastructure and automotive segment of Silicon Labs over the summer of 2021, giving Skyworks a new high-growth market for its engineers and fabs to serve. These non-smartphone markets remain in year-over-year growth and now represent just over one-third of total sales.
This is all great news in my mind. Once smartphone markets bottom (sometime during the first half of next year, by Skyworks' estimate), the company will have lots of new opportunities ahead of it. 5G mobile rollout is still ongoing, automotive technology and electric vehicle charging infrastructure is taking off, and data centers supporting the cloud continue to supplant traditional IT. At just 12 times trailing 12-month earnings, or 16 times trailing 12-month free cash flow, Skyworks looks mighty cheap to me at the moment.
