Chip stocks are down, but they're far from out right now. In fact, global chip sales are expected to go on an epic run over the next decade, driven by myriad secular growth trends ranging from cloud computing to artificial intelligence (AI) to electric vehicles. Various estimates point to semiconductors going from about a $600 billion industry in 2022 to well over $1 trillion by the end of the decade.  

It will be a bumpy ride up, though, since chip sales are cyclical. In fact, a down cycle is in effect right now. But two little-known, yet critical companies to the semiconductor industry -- Synopsys (SNPS 1.24%) and Cadence Design Systems (CDNS 1.37%) -- could be fantastic investments along the way. Here's why these two software plays on the computing hardware space are key stocks to consider for 2023. 

The next wave of computing innovation is happening now

To push computing performance to new heights, chip designers are adopting new ways of packaging semiconductor systems -- like chiplets, multiple smaller chips assembled into a larger integrated circuit. Some chip designers like Intel think multiple vendors will be involved in supplying the parts for a chiplet computing architecture model. 

Other innovations include embedding software into chips early in the design process. Software technologies are also helping speed up development times with features like molecular-level simulation of chips, AI tools to solve design problems, and using pre-designed customizable circuits to accelerate overall design.

All of this requires a complex suite of software to coordinate all the various engineering teams and stakeholders involved in designing modern computing systems. That's where Synopsys and Cadence come in. There is a lot of overlap between what these two software companies do, but together -- along with Mentor, which is now owned by German industrial conglomerate Siemens -- they are a critical part of the chip industry known as electronic design automation (EDA) software. Be it a semiconductor designer, a chip manufacturer, a computing system assembler, or a software engineer, there's a good chance that Synopsys or Cadence is an important part of the software lineup being used. 

And because Synopsys and Cadence are mostly subscription-based models, they put up consistent growth numbers. That stands in stark contrast to many other chip companies that ebb and flow with the economy or cycles of semiconductor sales booms and busts. 

CDNS Revenue (TTM) Chart

Data by YCharts.

The result is some differentiated stock price performance. Owing to their similarities, Synopsys and Cadence shares trade in close lockstep with each other, but both are handily beating the market in 2022.

Put these two stocks on your watch list

Due to their premium valuations, I've been putting off buying either Synopsys or Cadence Design. But as 2023 nears and the next wave of computing technology starts to get commercialized, I'm ready to start buying. I'll be using a dollar-cost averaging method, likely adding to one or both stocks on a monthly basis early in the next year. 

The premium price tags for both (Synopsys trades for 32 times trailing-12-month free cash flow, Cadence for 42) look well deserved. Both companies are growing at a steady rate, they're highly profitable, have stellar balance sheets, and are repurchasing stock.  

Metric

Synopsys

Cadence Design Systems

Most recent quarter revenue growth

11.5%

20%

Trailing-12-month operating profit margin

23.1%

30.8%

Trailing-12-month free cash flow profit margin

31.5%

31.7%

Trailing-12-month stock buybacks

$862 million

$865 million

Total cash and short-term investments

$1.57 billion

$1.09 billion

Total debt

$20.8 million

$798 million

Data sources: Synopsys and Cadence Design Systems.

One note to keep in mind: Cadence recently acquired molecular modeling and simulation software company OpenEye Scientific, which it also took on some new debt to purchase. Synopsys also grew sales by 21% during its recently concluded 2022 fiscal year, so the growth profiles for the two companies are much closer than what the most recent quarter would indicate.

But make no mistake, a decade of new computing technology advances is poised and ready to go. Synopsys and Cadence Design will play a crucial role in their development and commercialization. As such, I think these two stocks should be staples for semiconductor investors in 2023.