We generally use our electronic gadgets without thinking, expecting them to understand our operating environment, read our commands correctly and store, retrieve and process the information we throw at them.
But what goes on behind the process is complicated, and enabled by semiconductor technology, whether analog (enabling the recording and measurement of real world information), digital (processing information available in machine-readable language) or mixed signal (enabling conversion of analog signals to digital or digital to analog among other things). So most electronic gadgets use a combination of these semiconductor devices.
The industry is cyclical, making for periods of expanding capacity and supply that outpace demand followed by periods during which the growing demand matches then exceeds supply. So there is a certain elasticity in prices. Moreover, these semiconductor components have wide application across automotive, communications, computing/cloud/data center, industrial, medical and other markets, so players can serve multiple markets that offset their individual seasonality.
Some of the leading players in the industry include Analog Devices (ADI) and Maxim Integrated Products (MXIM).
Here are three major themes in the industry:
- The most important theme at this point is the impact of the coronavirus. And this impact is both significant (considering the effect on both the demand and supply sides) and hard to pin (because it’s changing every day). The problem started in China, so it was the supply chain that was impacted initially. But because of channel inventories and seasonal softness in the first quarter, numbers, while being weak, didn’t quite capture the whole effect. So the final weeks of the first quarter and the initial weeks of the second quarter comprised the period during which most of the weakness was felt, not only on the supply side but also on the demand side. Reports indicate that Asian countries involved in chip making, packaging, etc have adjusted to the new normal as far as semiconductor production is concerned. With the whole world coming out of lockdowns and shelter-in-place orders, demand for new devices that consume chips are seeing increasing demand. R&D budgets, focused on responding to increased competition and the expanding scope of digitization, are likely to increase gradually from here on. This is a good time to grow capabilities and acquire talent on the cheap. However, M&A, which has anyway become more difficult because a significant amount of industry consolidation has already happened, is likely to remain sluggish.
- Secular drivers like data center growth (from the continuing shift in workloads to the cloud, which has accelerated in the current situation), artificial intelligence, IoT, automotive (driven by the amount of electronics per car, automation, clean energy, etc) remain and they continue to expand the scope of computing. Demand for traditional computing equipment like PCs and even newer-age tablets and Chromebooks (generally considered to be in the high-volume category) should remain strong as more work and education is done at home.
- The adoption of 5G communications technology, enabling 10X the data rate as 4G, will be a huge boost to analog-mixed signal sales both in base stations and end devices. Because of the multiple input (MI) and multiple output (MO) streams the technology will enable in base stations, demand for sensors and power management analog including envelope tracking chips (to manage excess power flow and thus reduce heating), as well as gallium nitride (GaN) materials will increase. Moreover, since 5G is only involved in short range signals, it will not totally replace 4G but will supplement it. So it will be additive in terms of component demand.
The challenge of rising cost and complications of fabricating chips remains while their broader adoption across devices of varying value requires prices to decrease.
There’s also a longer term challenge with respect to China, which is bringing new fabs online. The increased supply will bring down prices and dampen sales for American players in some categories, likely by next year. The outcome of the ongoing trade war increases uncertainties.
Zacks Industry Rank Indicates Attractive Prospects
The Zacks Semiconductor – Analog and Mixed industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #59, which places it in the top 23% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates improving near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
The industry’s positioning in the top 50% of the Zacks-ranked industries is a result of improving earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts have been gaining confidence in this group’s earnings growth potential since June. While the industry’s earnings estimate for the current year is down 31.7% over the past year, it is up 6% from May. Ditto for the 2021 estimate, which is down 26.5% over the past year but up 5.7% from the May low.
Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.
Industry Lags on Stock Market Performance
The Zacks Semiconductor – Analog and Mixed Industry has traded roughly in line with the S&P 500 over the past year although it pulled ahead in June. However, it fell behind the broader Zacks Computer and Technology Sector in January-end and hasn’t fully recovered yet.
Overall, the industry gained 21.4% in value during this period compared to the broader sector’s increase of 36.7% and S&P 500 index’s increase of 15.4%.
One-Year Price Performance
Industry’s Current Valuation
On the basis of forward 12-month price-to-earnings (P/E) ratio, which is a commonly used multiple for valuing semiconductor companies, we see that the industry is currently trading at 25.6X compared to the S&P 500’s 22.6X. It is however slightly undervalued compared to the sector’s forward-12-month P/E of 26.3X.
The industry is currently trading between its high and median values of 27.1X to 21.1X, as the chart below shows. Both the S&P 500 and the broader sector are trading at their annual highs.
Forward 12 Month Price-to-Earnings (P/E) Ratio
It is apparent that the current market is not conducive to sales, as the trade tensions between the U.S. and China have merged into the even greater calamity of the coronavirus. There is also cut-throat competition between players in most segments. So discounts, promotions and optimum inventory management typically define their strategies.
Despite the many considerations, the increasing demand is unmistakable. That’s what makes us cautiously optimistic about the Zacks Semiconductor – Analog and Mixed industry. So here are a handful of buy-ranked companies in the industry that you may want to add to your portfolio-
Analog Devices, Inc. (ADI): Shares of this supplier of analog, mixed signal and digital signal processing (DSP) integrated circuits for industrial, consumer, communications and automotive applications have appreciated 8.3% over the past year. Its current Zacks Consensus EPS Estimate for the current fiscal year has increased 38 cents (8.9%) in the last 30 days.
Price and Consensus: ADI
Maxim Integrated Products, Inc. (MXIM): This original equipment manufacturer (OEM) of semiconductor analog and mixed signal integrated circuits for consumer, computing, industrial, automotive and communications applications saw its share price increase 28.5% in the past year. Its current Zacks Consensus EPS Estimate is up 28 cents (12.7%) in the last 30 days.
Price and Consensus: MXIM
Microchip Technology Inc. (MCHP): The company designs and manufactures microcontrollers, memory and analog and interface products for embedded control systems, which are small, low-power computers designed to perform specific tasks. It has seen a 25.4% jump in its share price over the past year. Its current Zacks Consensus EPS Estimate jumped 10 cents (1.8%) in the last 30 days.
Price and Consensus: MCHP
Silicon Laboratories, Inc. (SLAB): This designer and manufacturer of analog and mixed-signal semiconductor products for IoT, infrastructure, industrial automation, consumer and automotive markets has seen a 1.6% increase in its share price over the past year. Its current Zacks Consensus EPS Estimate has remained unchanged in the last 30 days.
Price and Consensus: SLAB
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