Technology stocks and exchange traded funds (ETFs) delivered strong first-quarter performances with semiconductors acting as one of the integral drivers of technology strength in the first three quarters of the year.
Consider the following: the tech-heavy Nasdaq-100 Index gained 16.20 percent in the first quarter, but the iShares PHLX Semiconductor ETF (SOXX) surged 20.40 percent during that period. The $1.14 billion SOXX tracks the PHLX SOX Semiconductor Sector Index, one of the most widely followed gauges of semiconductor stocks. That means SOXX has already wiped out its 2018 loss of 6.50 percent and much more.
While the rally in technology stocks has boosted valuations on the group, some analysts believe chip stocks are not yet too stretched on valuation and see opportunities within the group.
“Despite the recent rally in tech and in semiconductors specifically, we still think semis are the most undervalued subsector in technology, as about 30 percent of our coverage is 4-star-rated or higher and the median chip stock is about 4 percent below our fair value estimate,” said Morningstar in a note out Monday.
To that point, multiples on SOXX are not far off those of the broader market. The semiconductor ETF has a price-to-earnings ratio of 16.63x, according to issuer data.
Innovation Is Important
The technology sector is rife with disruptive, innovative products and services and semiconductors often serve as the backbones of those themes. Semiconductor makers are at the epicenter of potentially transformative themes, such as 5G and artificial intelligence (AI).
“Semiconductor suppliers are potential early winners from this ongoing shift,” according to BlackRock. “They are set to benefit from a significant increase in demand for the data and infrastructure required to handle the network traffic. Fiber and testing companies also stand to benefit as 5G infrastructure is built out and new 5G applications are tested.”
Another potential tailwind for SOXX and some of the 30 stocks residing the in chip ETF is easing of trade tensions between the U.S. and China. In fact, that was an important driver of semiconductor stocks' performance in the first three months of the year.
“However, a good portion of the bounce-back in semis in the first quarter came from optimism about easing trade tensions between the U.S. and China, as well as some commentary suggesting that the March quarter will be a bottom for chip demand,” said Morningstar.
Another fertile territory for chip is the global automotive market, which is expected to boost demand for processing chips over the next several years, as highlighted by the chart below.
Courtesy: Morningstar
Catalysts For SOXX
As noted above, SOXX holds 30 stocks. The fund devotes over 19 percent of its combined weight to NVIDIA Copr. (NVDA) and Broadcom Corp. (AVGO). Some of the fund's other marquee components could also contribute to upside for SOXX as 2019 moves along. That includes Applied Materials Inc. (AMAT), the seventh-largest holding in SOXX at 4 percent of the ETF's weight.
“We believe wide-moat Applied Materials' shares are trading at an attractive discount,” said Morningstar. “The company has benefited greatly from the sharp rise in spending by memory and display chipmakers over the past few years, though recent customer commentary suggests a near-term pullback in spending for each subsegment (especially in 3D NAND memory and OLED displays). Although we think total wafer front end spending will be modestly lower in 2019, we foresee Applied leveraging the breadth of its product portfolio and services business to navigate this softer demand.”
Morningstar star has a fair value estimate of $49 on shares of Applied Materials, indicating potentially significant upside from current levels of around $42.60.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
