As a global semiconductor shortage affects everything from computers to the auto industry, companies like Nvidia (NVDA) - Get NVIDIA Corporation Report and Advance Micro Devices (AMD) - Get Advanced Micro Devices, Inc. Report are on every investor’s radar. The soaring demand for the silicon chip used in countless electronic devices has propelled the shares of both companies, as well as many others, astronomically.
But while soaring stock prices may make backing the big players feel like a no-brainer, the volatility of the industry means that newer or smaller companies with potential for major growth are constantly emerging. Due to the industry’s dependence on factors such as foreign supply and U.S.-China diplomacy, it is not always as simple as looking at current sales and growth to dictate long-term investing strategy.
One such example would be Taiwan Semiconductor Manufacturing (TSM) - Get Taiwan Semiconductor Manufacturing Co., Ltd. Sponsored ADR Report.
The stock of Taiwan Semi, one of the world’s largest independent semiconductor foundries, has risen by 120% in the last year. But it may have reached peak valuation as more companies making similar products come onto the market. According to a research report from World Semiconductor Trade Statistic, the global semiconductor market is projected to grow by 19.71% to $527 billion in 2021.
“I think that we're going to see a significant increase in chip manufacturing and that's going to lead to some incredible opportunities, especially in some of these ancillary players,” Quint Tatro, the chief investment officer of advisory firm Joule Financial , told TheStreet. “Companies will meet the demand and start pumping out chips like no other.”
Globally, there are now more than 750 companies making semiconductors - other strong players include NXP Semiconductors (NXPI) - Get NXP Semiconductors NV Report, Applied Materials (AMAT) - Get Applied Materials, Inc. Report and KLA (KLAC) - Get KLA Corporation (KLAC) Report. In the United States, Intel (INTC) - Get Intel Corporation (INTC) Report and Qualcomm (QCOM) - Get QUALCOMM Incorporated Report have been making semiconductor technology for decades. Globally, Asia Pacific dominates with more than 60% of the world’s sales.
But while the spotlight is currently on those that actually make semiconductors, ancillary products are just as necessary to ramp up manufacturing while treated like a secondary investment. According to Tatro, investors should be keeping a close eye on Axcelis Technologies (ACLS) - Get Axcelis Technologies, Inc. Report, a Massachusetts-based company from which Taiwan Semiconductor buys its manufacturing equipment. He said that the company compounded its book value at over 16% over the last five years while trading at a multiple of 15, a cheap investment given its potential for growth.
“If you think of Taiwan Semiconductor’s [manufacturing plans], they’re going to need increased fabrication equipment to actually produce the semiconductors,” Tatro said. “Our belief is that we will see a ramp-up in orders for Axcelis fabrication equipment that will benefit the company greatly.”
Another is the Taiwan-based mCore Technology, which specializes in the packaging that surrounds the semiconductor chips. Tatro explained that after receiving the semiconductors from Taiwan Semiconductor, Intel and Apple (AAPL) - Get Apple Inc. (AAPL) Report, the company packages them in a way that makes them ready to enter a product like a computer. Surging demand means that the company's revenue grew 25% year over year while net income increased by almost 200%.
“Similarly to Axcelis, mCore should be an absolute benefactor from the increase in manufacturing in growing revenue,” Tatro said. “[…] They've got about 42% debt to equity so it's a little more debt than that I'd like to see but they have strong cash flows and we believe that with a forward multiple of under 11, this company is undervalued and poised for this sort of ancillary ramp-up in manufacturing.”
Defiance ETFs co-founder and chief investment officer, Sylvia Jablonski, said other lesser-known names are Qorvo (QRVO) - Get Qorvo, Inc. Report, whose growth likely will be very strong as more of the wireless industry transitions to the 5G technology in which the company specializes.
MaxLinear (MXL) - Get MaxLinear inc Report and GCP Applied Technologies (GCP) - Get GCP Applied Technologies, Inc. Report are fast approaching major breakthrough in profitability while companies like Texas Instruments (TXN) - Get Texas Instruments Incorporated Report are valuable because they have their own foundries and will be protected from global shortages.
“All of these companies make the list for me because they are pretty much in the ideal situation for constructing the basic equipment to deploy the 5G technology,” Jablonski told TheStreet.
“Any company that is linked to that is going to experience healthier profit margins,” Jablonski added.
Investors whose only knowledge of semiconductors comes from the current investment buzz may also consider starting out with an ETF, Jablonski advised. Along with her company’s 5G ETF (FIVG) - Get Defiance Next Gen Connectivity ETF Report, VanEck Vectors Semiconductor ET (SMH) - Get VanEck Vectors Semiconductor ETF Report and iShares Semiconductor ETF (SOXX) - Get iShares PHLX Semiconductor ETF Report include both major players and less-talked-about companies like Entegris (ENTG) - Get Entegris, Inc. Report and ASE Technology (ASX) - Get ASE Technology Holding Co., Ltd. Sponsored ADR Report.
By dipping one’s toes with broad-based exposure to the industry, potential investors will be able to track the different holdings and have a better understanding of individual companies to watch out for.
But overall, Jablonski said that picking the right company is less important than getting into the industry generally. The chip shortage is not going anywhere soon and, with data from the Semiconductor Industry Association showing that a finished chip can take up to 26 weeks to manufacture, the investment opportunities should remain strong for at least the next five years.
"There's been a lot of talk by (President) Biden about the 5G infrastructure package and connecting rural and urban America,” Jablonski said.
“A lot of the companies that allow all that to happen are semiconductor companies. There is no machine-to-machine communication, no automation processing, no AI or any of the other massive innovations in our future without semiconductors," Jablonski said.