1 Chip Stock to Avoid and 2 Chip Stocks to Consider for 2023

Semiconductor stocks are on an upswing in the last few months. As measured by the iShares Semiconductor ETF, shares of chip companies are up some 40% since their lows in October 2022. Investors are peering beyond the current cyclical downturn (led by flagging smartphone and PC sales) and looking toward a rally in the back half of 2023. With a decade of strong growth expected for the industry, small semiconductor companies could hold a lot of promise. 

But not every chip business is in the same boat. Wolfspeed (WOLF -6.49%) is going through some serious growing pains, but it still trades for a premium price. Onto Innovation (ONTO -4.64%) and SkyWater Technology (SKYT -2.78%), on the other hand, are forecasting better times ahead. Here are the details on these small emerging semiconductor companies and why two are worth considering and a third is one to avoid. 

Wolfspeed: Speed bumps for a new chip substrate

Silicon is almost synonymous with the chip industry. The base material is abundant around the globe, and it is an ideal semiconductive material that was put to use in chip technology right from the get-go when modern "chips" were invented in the 1940s and 1950s. In reality, though, the chemistry behind producing the basic materials for computing systems is much more complex than simple silicon. 

Silicon carbide (SiC) is one of these newer and more complex chip substrates, a compound made of silicon with carbon mixed in. The duo is especially potent at dealing with high-voltage applications -- making it a great substrate for chips used in electric vehicles (EVs) and renewable energy projects. With interest in EVs and renewables on the rise, Wolfspeed (formerly the LED light company Cree before a major corporate reshuffle) has bet its future on SiC manufacturing. 

However, contrary to how it may appear, the company isn't a pure play on SiC. In fact, it's gallium nitride (GaN) chips, used in power and mobility applications, that are accounting for a large portion of revenue. And GaN is hitting some hiccups right now due to the downturn in smartphone sales and related 5G network construction. Wolfspeed is also still in the process of bringing production online for its new SiC facilities in North Carolina and New York. Another SiC fab is being planned in Germany.

Building new fabs is a long and expensive process, and Wolfspeed has a lot to prove. On a quarterly sequential basis, Wolfspeed anticipates flattish revenue growth for the three-month period that will end in March 2023. Adjusted net losses are expected to be $15 million to $20 million on revenue of $210 million to $230 million. It also remains to be seen just how profitable Wolfspeed can be once it gets its SiC projects up and running. 

Given the present situation (flattening revenue and continuing losses), Wolfspeed stock looks mighty expensive at 11 times trailing-12-month sales, or 7 times one-year forward expected sales. I have Wolfspeed on my "hold off" list for now, though I'm still following the company due to its promise as a possible key supplier to the EV industry. 

Onto Innovation: Advanced chip manufacturing requires new equipment

It's often overlooked that chip manufacturing is an industrial business as much as it is a technological one. Making semiconductors requires highly sophisticated and expensive machines. Over the decades, the chip fab equipment (CFE) segment of the chip industry has consolidated down into just a small handful of players. One of these top companies is chip process control and chip measurement (known as metrology) equipment maker KLA Corp. 

But KLA has a small competitor that is making some dough off of new advanced chipmaking processes: Onto Innovation. The company is the product of a 2019 merger between two smaller names in the CFE space. Onto provides specialized inspection equipment addressing wafer manufacturing and chip packaging technology as chip design has reached an incredibly tiny microscopic scale.

The CFE segment of the chip industry is undergoing a downturn as many fab customers pare back their spending on equipment. But this headwind is expected to die down by the second half of 2023. And in the meantime, Onto is holding on to big gains it picked up the last couple years of chip industry boomtime. It grew revenue 27% in 2022. For Q1 2023, management expects revenue to be about $200 million, which would represent a year-over-year decline of about 17%. Earnings per share (EPS) are expected to be down 43% at the midpoint of guidance. Overall, though, profit margins rose at a much faster pace than revenue last year, exactly what investors want to see from a small manufacturing company that is getting more efficient as it scales up.

There will be bumps in the year ahead as Onto deals with cyclical spending hiccups from its customers in the coming quarters. Nevertheless, Onto is a promising business in the CFE space that will benefit from the rising complexities of making semiconductors in the decade ahead. Shares look like a very reasonable value at just under 17 times trailing 12-month EPS as of this writing. This stock is worth close consideration right now. 

SkyWater Technology: A chip stock to bet on the "space industry"

SkyWater Technology is a relative newcomer to the semiconductor industry. It was formed in 2017 when industrial holding company and private equity investor Oxbow Industries purchased a chip manufacturing facility in Minnesota from Cypress Semiconductor (which has since been acquired by Germany's leading semiconductor company Infineon). SkyWater completed an IPO in early 2021, and Oxbow retains a more-than-50% stake in SkyWater. It's a short and convoluted history, but SkyWater is piecing together an interesting business.

SkyWater stock has sold off hard since 2021 as the bear market took its toll on richly valued tech stocks, especially those like SkyWater that don't turn a profit. But SkyWater is making solid progress. Its business model involves co-creating chip technology and manufacturing processes with its customers, and then using its fab to help ramp up production of the resulting new technology. 

Key agreements were signed in 2022 with large manufacturer GlobalFoundries (NASDAQ: GFS) for producing industrial chips for the U.S. Department of Defense, which has granted money to SkyWater for development of its radiation-hardened (rad-hard) chip process. Rad-hard chips are needed for deep space deployments, satellites, and the like, making SkyWater a "picks-and-shovels" play on the space economy. Other customers it serves operate in the automotive and biomedical industries.

SkyWater reported revenue of $213 million in 2022, up 31% year-over-year -- including a 69% year-over-year advance in revenue during the fourth quarter to $65.1 million. Management expects 2023 revenue growth to come in near their average "long-term objective of 25% annually." Importantly, as tiny SkyWater scales up, it's approaching breakeven. Net loss in Q4 2022 was only $3 million, compared to a loss of $27 million the year prior.

Given its small size and the fact it still isn't turning a profit, I expect SkyWater shares to remain highly volatile. I'm not ready to buy yet. I'm doing more research on the business, and would like to see more progress on scaling up its manufacturing, since the company is still free-cash-flow negative and a bit short on cash on the balance sheet ($30 million at the start of 2023). Nevertheless, SkyWater has my attention. Shares trade for 2.9 times trailing-12-month sales, which could be a long-term value if this small chip manufacturer can achieve its goals.