Finding the Next Great Semiconductor Stock
Meme stocks have shown just how much temporary influence retail investors can have on the stock market. Look no further than the recent surge in any stock associated with the letters “AI.” If ChatGPT is churning out amusing copy, it must be a great time to buy “AI stocks,” right? Never mind doing any due diligence, just search for company names that contain AI. A similar behavior was observed nearly two decades ago when companies with “nano” in the name soared to the moon.
Then there’s the often repeated mistake of ticker confusion which isn’t just about fat fingering the wrong ticker. Researchers have shows remarkable return profiles associated with tickers that look the same. From an article by Quartz:
One spectacular example was when, as the researchers document, the stock price of Tweeter Home Entertainment Group surged by more than 1,000% on Oct. 4, 2013. The company traded under the ticker TWTRQ, and social media giant Twitter had just filed plans for its IPO—it listed the following month, with the ticker TWTR.
Even the trading algorithms get it wrong every now and then, something known as “the Anne Hathaway Effect.”
The power of a company’s brand can also have an impact on investor perceptions. For example, one of the more popular search phrases surrounding semiconductor stocks is, “is NVIDIA the next Intel?” At least based on market cap, the answer is a resounding yes, as NVIDIA is 4X the size of Intel. But when it comes to revenues, Intel produces nearly twice as much as NVIDIA. This is where growth comes into play.
39 Semiconductors Stocks
In our recent piece on Finding the Best Semiconductor Stocks, we looked at three semiconductor ETFs that might provide a universe of stocks we can use to find the next semiconductor success story. In particular, the SPDR S&P Semiconductor ETF contains a good mix of midsized semiconductor stocks to start vetting. First, we download the list of stocks from the ETF provider’s website, then enable the Refinitiv data plugin which allows us to automatically import fundamental data points such as market cap.
The first step will be to remove all mega cap stocks – above $100 billion market cap – which fall outside our ideal size threshold. In other words, the below stocks have already realized a great deal of their potential.
After excluding mega cap stocks, we can then remove anything that’s too small. Even though four names fall under our $1 billion market cap threshold, we’ll retain anything above a $500 million market cap to provide a buffer. That means Meta Materials falls off our list, which is great, because it’s an absolute rubbish company.
Next, let’s look to remove companies that have been around for three decades or more and haven’t been able to make things happen. Since technologies are being brought to market faster than ever, older technology companies have missed their chance to excel. NVIDIA took 30 years to become the largest semiconductor company in the world, so let’s say that companies older than 30 years have been spinning wheels too long in technologies that wouldn’t be considered disruptive enough to change an entire industry. That means eight more names fall off our radar:
We’re now left with 20 semiconductor stocks to vet using two important metrics. First, gross margin tells us just how viable a company’s business is. If you’ve developed a technology that’s defensible with a strong intellectual property portfolio, you can command very high gross margins without other competitors coming to steel the loot. With a market cap of half a trillion dollars, NVIDIA still manages to sell hardware at a gross margin of 65%. While they’re seeing pressures on those gross margins lately, that underscores the important of having such strong margins to begin with.
As for revenue growth, examining the compound annual growth rate over the past four years is convenient for several reasons. First, these data points can easily be looked up on Yahoo Finance for any given stock. Second, they paint a good picture of how a company might perform in times of economic turmoil given that this time period encompasses The Rona. So, if we exclude all companies that don’t have revenue growth of at least 20% over the past four years, the following 15 companies fall off our radar.
Questions might arise around why the arbitrary cutoff of 20% was chosen. Other than the fact that it’s a nice round number, it also meshes well with our benchmark – NVIIDA – which managed to achieve a 4-year revenue CAGR of 23% despite that it’s a half a billion-dollar company. In the earlier stages of a growth company’s lifecycle, we should expect to see higher growth levels than that. Despite the fact we’ve set our benchmark quite low, let’s vet the five names we’re left with.
Five Semiconductor Stocks of Interest
SiTime (SITM) is a leader in MEMS timing solutions, having shipped over 1.5 billion units. Precision timing is the heartbeat of every electronic system, says the company, and they estimate their TAM to reach $10 billion by 2024. Several years ago, they launched two new product lines with intentions of targeting this opportunity.
SiTime’s recent earnings call talks about the usual revenue growth impact from supply chain problems along with an increasing TAM as they expand product lines. The investor deck is riddled with mentions of all the disruptive tech themes they address, and their strong revenue growth (4-yr CAGR of 27%) points to progress being made in some or all of these areas (we can’t tell because revenue breakdown granularity isn’t provided). Gross margins in the mid-60s point to intellectual property leadership. Were we looking for more semiconductor exposure, we’d come back around for a closer look at SiTime.
Monolithic Power Systems
Monolithic Power Systems (MPWR) or MPS, grows regardless of the market environment, says the company, and we’re inclined to believe that’s the case based on their track record. Just look how well they’re diversified across various industry verticals that are all experiencing tremendous growth.
That said, we’re inclined to view the company as a heavily diversified play across multiple industries more resembling a large industrials firm. The company’s rich valuation reflects their excellent execution over the years, and their dividend growth track record of five years means they’ve started down the path towards becoming a dividend champion. This seemingly great company may be too diversified to fit into our disruptive tech portfolio and not quite mature enough for our DGI portfolio.
Credo Technology Group
Credo (CRDO) plans to “deliver high-speed solutions to break bandwidth barriers on every wired connection in the data infrastructure market.” Sounds good on the tin, but we immediately run into an information problem. The lack of a simple investor deck, or any sort of quarterly presentations, means we’re forced to start scrutinizing SEC filings to understand what exactly they do. Customer and geographic concentration risks immediately stand out with sales to Mainland China accounting for 56% of revenues for the first six months of Fiscal 2023, a huge jump from the year prior.
A single customer accounted for 44% of total revenues last quarter (three customers accounted for 79% of total revenues with similar concentrations seen for the same period last year). The Cayman Island structured firm has subsidiaries in Taiwan and the PRC which means there’s a layer of complexity that adds risk and requires further due diligence. The company is “engaged with five of the top seven hyperscalers,” and appears to be doing business with both Amazon and Microsoft. More due diligence would be needed to evaluate this firm which has a rich simple valuation ratio of 25. Exposure to the growth of big data through hardware is quite appealing, which is a good segue into our next company.
Whenever there’s an M&A event involving two firms, it’s always best to wait for the dust to settle. Maxlinear (MXL) is a leading semiconductor supplier in broadband, connectivity, and infrastructure, all areas that benefit from the explosive growth of big data. They plan to acquire another semiconductor firm, SiliconMotion (SIMO), that dabbles in NAND flash controller technology, an area we’ve covered before in our article on Investing in Data Storage Hardware Stocks. The transaction is expected to close in the first half of this year, and investors should wait until that happens before evaluating an investment in either firm.
The smallest company in our final five, Navitas (NVTS), also happens to have the highest growth rate and valuation. A simple valuation ratio of 37 means this stock is likely being hyped, and that means the value proposition is easy to understand. You’re best served by starting with our article on Investing in Gallium Nitride and Silicon Carbide, two potentially disruptive semiconductor materials. The entire appeal of Navitas surrounds their development of semiconductor hardware using both these materials following a recent merger which positions them as a leader in this niche. That said, if it’s GAN/SIC exposure you’re looking for, why not just invest in Wolfspeed Stock: A Bet on Electric Vehicles and More?
The Next Great Semiconductor Stock
Trying to replicate NVIDIA’s success story means we need to identify the ideal characteristics of a promising company (we don’t invest in stocks, we invest in companies). Too much diversification across sectors dilutes the value proposition, but focusing on a single industry increases risk. The ideal company would have a leadership position in multiple industries/sectors/niches similar to how NVIDIA dominates in gaming, data centers, and AI chips. Domination allows for high gross margins. Strong revenue growth come from identifying verticals that each experience revenue growth because they’re exposed to disruptive themes. A core product offering developed into very specific products addressing each niche is more desirable as it allows for dominance as opposed to 100s of products (as seen in the case of MPS). For NVIDIA, this core product would be their GPUs which are leveraged into all their business segments.
With NVIDIA as our largest position, and 17% of our total portfolio exposed to semiconductors, we’re not looking for more ways to play this sector. Strong interest from our paying subscribers means we’ll continue to explore this space in a series of articles that look to uncover interesting growth plays that may represent the next Intel or NVIDIA, depending on what you’re looking for. In our third article of this series, we’ll look to explore a semiconductor software play we like – Synopsys (SNPS) – and see how they stand up to their major competitor, Cadence (CDNS).
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