Semiconductor Valuations Going Through the Roof, 2 Stocks with Equally Strong Prospects
Companies in the Semiconductor – General industry are at the forefront of the ongoing technological revolution based on HPC, AI, electrified and automated driving, IoT and so forth. The semiconductors they produce enable the cloud to function and help analyze the data into actionable insights that can be used by companies to operate more efficiently.
Despite negative forecasts from economists and market watchers alike, 2023 turned out to be stronger than initially expected. In 2024, although inflation is not at targeted levels, we may eventually see the government cut rates.
Semiconductor growth forecasts reflect the positive outlook. According to the latest data coming out of WSTS, which is also typically quoted by the Semiconductor Industry Association (SIA), global semiconductor sales dropped 8.2% in 2023. Moreover, the SIA expects that the second half strength will continue this year, leading to double-digit sales growth in 2024.
Gartner is optimistic about 16.8% growth in 2024. The main driver is the memory segment, where excess inventory was depressing prices in 2023 and resultant production cuts are expected to lead to shortages and therefore, price increases this year, according to DIGITIMES Research. IDC is perhaps the most optimistic, projecting 20% growth in 2024.
As far as end markets are concerned, growth in PCs and smartphones will come from new AI-enabled versions starting this year. PC growth will also be driven by the end of support for Windows 10. Commercial and enterprise deployment should also increase as a soft-landing for the economy looks increasingly likely.
Driven by Internet connectivity across the developed and developing worlds and supportive technology such as sensor networks and AI adoption, the IoT market is also expected to grow steadily over the next few years. Future Market Insights expects the industrial IoT segment alone to grow at a 12.1% CAGR between 2023 and 2033.
Auto electrification, structural changes in industrial automation, data center strength, generative AI and custom chips for cloud services are expected to drive multi-year growth in semiconductors. While in the past, memory demand has been tied to PCs and servers, which is the main reason for the pandemic-related imbalance in 2023, auto and server applications will continue to grow in the coming years.
The government’s target of reducing dependence on China, and onshoring projects with national security implications will shape the future of this industry.
As the outlook has turned rosier through 2023, share prices have also soared, leading to rich valuations. This scenario continues into 2024. Despite this, companies like NVIDIA Corp. NVDA and SCREEN Holdings DINRF are worth buying.
About The Industry
This industry includes mostly semiconductor chip manufacturers like Intel Corporation (INTC).
Factors Driving the Industry
The long-term outlook for the industry has been robust for a while now because it's on the building-block side of technology, which makes it crucial for the proliferation of the Internet and the ongoing digitization of every aspect of life. However, the short-term outlook continues to brighten. With interest rates stabilizing and demand side factors such as the surging inflation moderating, we can finally focus on industry-specific issues. These too are looking up with the inventory imbalance corrected, AI-enabled end point devices coming to market this year and surging infrastructure demand stemming from the rapid adoption of generative AI. While global economies are only gradually returning to normal and geopolitical concerns remain, a very definite turn for the better is visible.
There is continued strength in emerging areas like AI and machine learning, IoT, and automotive. ReportLinker expects the AI chip market to grow at a CAGR of 34.5% between 2023 and 2028. The Business Research Company expects the market to grow over 38% this year and at a CAGR of over 40% between 2023 and 2028. Data-intensive applications, advancements in machine learning algorithms and increasing urbanization, as well as dynamics in the auto and financial services markets are the major drivers. Mordor Intelligence expects the IoT chip market to grow at a 14.7% CAGR between 2024 and 2029. Automotive electronics is another area of evolving needs and IDC expects that ADAS growing 19.8% through 2027 (30% of auto sales by then) and infotainment growing 14.6% through 2027 (20%) will be the most important drivers. Grand View Research estimates the auto chip market to benefit from electronic components in luxury to mass-produced cars, increasing adoption of electronic control unit (ECU) in modern vehicles and the growing focus on safety systems in vehicles. Infotainment, fuel efficiency and safety are expected to be the primary drivers as the world moves toward EVs and hybrids. Automation and robotics, with increasing adoption across industrial operations, are other areas of growth. These are secular drivers of demand for semiconductor components and will benefit industry players for years to come.
Semiconductor supply chains are adjusting. Semiconductor supply chains have become increasingly efficient over the years. While this has brought down cost, the just-in-time model has made the supply chains relatively unreliable in case of external disruptions, as happened during the pandemic, or when China imposed its zero tolerance COVID shutdowns. This, along with other factors, such as the U.S.-imposed restraints on dealing with China is leading semiconductor companies to diversify their supply chains and reduce their dependence on the country. This is an ongoing process that will take several years to accomplish. In the meantime, there is growing concern that all the most important leading-edge chips are currently made in Taiwan, a country that China threatens to annex all the time. Since this has national security implications, there is an ongoing drive to onshore or nearshore manufacturing. The $52 billion infusion from the CHIPS Act will help.
Zacks Industry Rank Indicates Moderating Prospects
The Zacks Semiconductor-General industry is a stock group within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #194, which places it in the bottom 23% of the 250 odd Zacks-classified industries.
The group’s Zacks Industry Rank, which is the average of the Zacks Rank of all the member stocks, indicates that near-term prospects are moderate. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of 2 to 1.
An industry’s positioning in the top 50% of Zacks-ranked industries is normally because the earnings outlook for the constituent companies in aggregate is relatively strong. The opposite is true for stocks in the bottom 50% of industries. In this case, the aggregate earnings estimate for 2024 is up 113.5% from the year-ago level while the aggregate earnings estimate for 2025 is up 101.8% from last year.
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.
Stock Market Performance Remains Strong
Tracking the performance of the Zacks Semiconductor – General Industry over the past year shows that the industry has traded at a premium to both the broader Zacks Computer and Technology Sector and the S&P 500 index throughout the year with a sizeable bump-up from the beginning of the year.
The industry has gained 142.7% over the past year. The broader technology sector gained 40.3% while the S&P 500 index gained just 23.5%.
One-Year Price Performance
Image Source: Zacks Investment Research
Current Valuation Is Rich
On the basis of forward 12-month price-to-earnings (P/E) ratio, we see that the industry is currently trading at a 37.02X multiple, which is a 1.1% premium to its median value of 36.51X over the past year. Additionally, it trades at a 41.8% premium to the sector’s 26.10X and a 78.4% premium to the S&P 500’s 20.75X. Therefore, any way you look at it, the industry is grossly overvalued.
Forward 12 Month Price-to-Earnings (P/E) Ratio
Image Source: Zacks Investment Research
2 Stocks to Consider
Despite the strong growth prospects, the industry’s high valuation keeps us on the sidelines. The current valuation also appears to be pricing in any benefits from expected interest rate cuts this year.
Therefore, although the industry consists of several technology heavyweights that are the backbone of how computing is done these days, and our consequent optimism on the segment for the long term, we can at the moment think of just 2 stocks worth picking up today:
NVIDIA Corp. (NVDA): Santa Clara, CA-based NVIDIA Corporation provides graphics, and compute and networking solutions in the U.S., Taiwan, China and other markets. Its graphics processing units (GPUs) are the most popular in the gaming segment. NVIDIA is also at the leading edge of enterprise, data center, cloud and automotive deployments today.
Generative AI is driving exponential growth in compute requirements. Because NVIDIA’s accelerated computing is versatile, energy-efficient and has low total cost of ownership, companies are rapidly transitioning to its products to train and deploy AI. NVIDIA GPUs, CPUs, networking, AI foundry services and NVIDIA AI Enterprise software are all growth engines. They are opening up opportunities and leading to broad-based growth across geographies and markets.
The automotive, financial services, healthcare and telecom verticals are particularly strong, as AI and accelerated computing are quickly becoming integral to customers' innovation road maps and competitive positioning. The data center business is the strongest right now, driven by demand for data processing, training and inference from large cloud-service providers and GPU-specialized ones, as well as from enterprise software and consumer Internet companies.
NVIDIA is also seeing momentum across professional visualization and automotive. All of these together led to 126% growth in the fiscal year ended Jan 2024.
The Zacks Consensus Estimate for fiscal 2025 (ending January) is up 10 cents (less than a percentage point) in the last 30 days and up 6 cents (practically flat) for the following year. These revisions are mere fine tuning. Analyst estimates after these adjustments represent earnings growth of 84.7% (on revenue growth of 74.7%) in 2025 and 13.9% (on revenue growth of 17.9%) in 2026.
The Zacks Rank #2 (Buy) stock is up 203.5% in the past year.
Price & Consensus: NVDA
Image Source: Zacks Investment Research
SCREEN Holdings Co Ltd. (DINRF):
Headquartered in Kyoto, Japan, SCREEN Holdings develops, manufactures, sells and maintains semiconductor production equipment in Japan.
SCREEN Holdings’ earnings estimate for the year ending Mar 2024 has increased 3 cents in the last 30 days while its 2025 estimate increased 6 cents. At these levels, they represent 4.7% earnings growth for the current year despite an estimated revenue decline of 2.5%. In the following year, earnings are expected to grow 10.8% on revenue growth of 5.6%.
The shares of the Zacks Rank #2 company have appreciated 164.6% over the past year.
Price Performance: DINRF
Image Source: Zacks Investment Research
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