
The Intel CEO Switch
Pat Gelsinger is taking over.
Semiconductor companies design and/or manufacture computer chips and related components. They are part of the technology sector, but are also manufacturers, which means their business is cyclical, as business is for companies in any manufacturing or commodity industry. Picking stocks in this industry can be tricky, and investing in them highly volatile, as sales ebb and flow.
Computer chips have many uses, but in the decade ahead, semiconductor stocks will likely focus on two areas of growth:
In the U.S. -- which accounted for nearly half of the $420 billion in global semiconductor spending in 2020, according to the Semiconductor Industry Association -- chips have grown to become the nation’s fourth-largest export. With one-fifth of semiconductor makers’ budgets being spent on research and development, these small hardware components are responsible for many technological advancements in other areas of the economy.
The U.S. accounted for nearly half of the $420 billion in global semiconductor spending in 2020.
These two companies are two of of the industry's most promising investments, as leaders in connectivity and GPUs, respectively, and the emerging markets they’ve focused on have meant higher-than-average profit margins. That means they’ve had money to invest in research to continue developing new products, pursuing new markets, and growing their revenue.
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When looking for the best semiconductor stocks to invest in, consider four key areas.
Investors generally prefer companies that can grow sales over time, but revenue growth matters even more for semiconductor stocks.
Many companies in this sector struggle to break out of the industry’s up-and-down cycles. Hardware, such as computer chips, tends to get commoditized over time. If one new market is growing quickly, other firms pile in with similar products; supply swells, prices fall, and sales shrink. If a company isn’t constantly innovating and finding new outlets for its sales, the cycle could wind up being a roller-coaster ride ending nowhere.
Sales don’t help much if a company can’t hold on to that cash on the bottom line. Think of profit margins as a net a company uses when hunting dollars. The higher the margins, the smaller the holes in the net, and the more dollars a company holds on to.
Investing in semiconductor businesses with tightly woven nets is important. The more dollars a company holds on to, the greater its ability to reinvest in research and improving its operations to ensure that its nets don’t spring any large holes.
So look at a semiconductor company’s gross profit (its revenue minus the cost of producing its products) and operating profit (gross profit minus other fixed and variable expenses like staff, research and development, and corporate overhead). The higher the gross and operating profit margins, the better, especially relative to a company’s closest peers.
A company’s returns on its investments can show you how well it’s able to innovate and continuously capture more dollars over time. Look at a semiconductor company’s return on invested capital. Higher returns mean the company’s better at innovating in the right places and improving operations to increase efficiency and the bottom line.
Finally, manufacturing tends to be expensive, so it’s important to note how semiconductor businesses have been using their resources to expand. Check how much cash and debt a semiconductor company has on its balance sheet. While debt alone isn’t a red flag, high debt relative to operating profit and cash on hand can be. On the other hand, plenty of cash relative to debt means a company has lots of wiggle room to invest or make acquisitions.
The five tech giants that make up a significant amount of the S&P 500 Index.
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These companies provide phone, internet, and television services -- along with the infrastructure that supports them.
Investing in semiconductor stocks, even those with the best prospects, can be a volatile journey. Investors would do best to buy during sales cycle slumps and reassess a company’s performance relative to peers during boom periods. Over the long term, though, these building blocks of technology will be profitable in spite of the ups and downs.
Pat Gelsinger is taking over.
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