Are semiconductor stocks ready to recover?
By Jenal Mehta
The semiconductor industry has soared in recent years, making as much as $500bn (£371.87) in collective annual sales in 2021 as reported previously by Capital.com. This trend is likely to continue, with most reports providing a robust outlook for the sector.
Yet despite soaring demand, semiconductor stocks have shown relative underperformance in recent months, with some stocks seemingly undervalued.
This is likely due to multiple pressures continuing from the pandemic, which notably resulted in severe supply-chain disruptions leading to global panic over semiconductor shortages. Further pressure has come in recent months with the added risk of geopolitical tensions.
However, when these pressures ease, semiconductor stocks are likely to see an uptick. The heightened demand means there is a continued strong outlook for this sector, with select growth stocks coming out on top.
Semiconductors – a growing demand
A semiconductor is a physical component in the form of a microchip that allows the current to flow in electrical devices; it is effectively used in everything we rely on today – computers, cars, mobile phones, tablets, washing machines, televisions... the list goes on.
Therefore, with the world moving increasingly more towards electrification, the demand for semiconductors has grown exponentially, and is likely to continue to do so.
According to data from the Semiconductor Industry Association, global sales of semiconductors has been steadily rising since 2000, with a 26.8% increase in sales occurring during 2021 alone. Demand for microchips grew 17% from 2019–2020, while global chip sales leaped by about 25% in 2021 to a peak of $583.5bn.
Further, data from Statista shows an increase of 25% in the value of the global semiconductor industry between 2019 and 2021, with a further growth of 9% predicted this year.
In a report, KPMG stated the highest demand for semiconductors in 2022 will come from sensors/microelectromechanical systems (MEMS), frequently used in the automotive industry, and microprocessors.
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Why are semiconductor stocks underperforming?
Despite the high sales levels, semiconductor stocks have been underperforming recently. The PHLX Semiconductor Index has seen a lower performance compared to Nasdaq 100 and the S&P 500, however this gap appears to have been closing over the past month.
Angelo Zino, senior industry analyst at CFRA Research, told Capital.com he believes the reason behind the relative underperformance is the multiple supply pressures across the industry, as well as the lingering effects of the pandemic since the past 15 months, which continue to affect the sector.
Rico Luman, senior sector economist at ING, said: “We still see supply pressure limiting production volumes in automotive. Manufacturers have a large backlog, and several car and truck manufacturers have produced vehicles without specific functionalities as a work-around, with the plan to fix this later.”
In an investor note, Zino clarifies that semiconductor growth stocks have performed relatively worse within the sector. He said: “Growth semis [stocks] have underperformed in value (-31% vs. -22%).
“At this point, semiconductor valuations are at the lower half of its trading band seen in the past several years, but if concerns about Ukraine–Russia were to intensify, it could set up an even greater ‘fear’ environment for chips [than that] seen during the pandemic in March 2020 and tariff bottoms (December 2018).”
Beyond chip shortage, a good outlook
The long-term outlook for the whole sector remains robust. However the lingering effects of the chip shortage since the pandemic are likely to remain for the short term.
In a survey 152 semiconductor global professionals, KPMG found that 56% foresee the semiconductor shortage continuing until 2023. At the same time, 95% believe semiconductor company revenues will grow in the coming year, 34% of which even predict a growth of more than 20%.
The KPMG report stated: “Confidence is at an all-time high, with surging demand in multiple-end applications driving business projections upward and accelerating the need for additional capacity.”
Luman shares the opinion that demand is strong within the sector, although fulfilling capacity may take time: “We also note that semiconductor demand growth remains solid and capacity expansion takes time. Consequently, the shortages won’t resolve in the next months.”
Good prospects – for those willing to wait
Despite semiconductor stocks’ underperformance and the ongoing pressures on the industry, CRFA’s Zino believes that “history has shown that moments like this tend to be buying opportunities for patient investors”.
He expanded: “If [the] Russia–Ukraine attacks were to de-escalate (ceasefire), chip stocks would be poised to rally and outperform the broader market, in our view.”
As to how investors can play the current market, Zino advised that select growth stocks are worth buying or holding amid the current correction. He said: “Growth-oriented names (specifically those tied to data centres) are the best way to play semis [semiconductor stocks], both in the near and long term.”
CFRA’s top growth stocks in the semiconductor industry, which it expects are the most likely to reap the benefits of increased semiconductor demand, are NVIDIA (NVDA), Advanced Micro Devices (AMD) and Marvell Technology (MRVL).