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Tech Stocks are Facing a Reckoning After Months of Rapid Gains

But some chip names still have relatively low valuations.

The benchmark PHLX Semiconductor Index  (SOX)   slid into a ditch last week, finishing down 4.04%. It continued its gyrations on Monday, trading in a 127 point range before ending the day off a modest 0.1%. The index is up about 34% on a year-to-date basis and 33.7% on a one-year timeframe.

Semiconductor stocks were battered last week, mostly tracking a broader slide in U.S. technology stocks, with the Nasdaq 100 technology Index down 5.45%.

With investors re-examining their technology stocks – for now, TheStreet’s Eric Jhonsa said the entire sector is facing a “reckoning” as 2022 draws to a close.

“Following month after month of speculative excess, we seem to be finally seeing a reckoning for high-multiple tech stocks in the wake of Jerome Powell & Co.'s recent hawkish turn -- a reckoning that's potentially being worsened by margin calls, blown options bets and fund redemptions,” Jhonsa said, writing in Real Money.

Jhonsa isn’t sure technology stocks have hit bottom yet.

“Valuations for many 2021 growth-investor favorites are still high, and it wouldn't surprise me if we need more capitulation in names such as Tesla  (TSLA) - Get Tesla Inc Report, Lucid  (LCID) - Get Lucid Group, Inc. Report  Rivian  (RIVN) - Get Rivian Automotive, Inc. Class A Report and Cloudflare  (NET) - Get Cloudflare Inc Class A Report,” he said. “Many of those stocks are still trading well above where they stood a few months ago and/or recently saw parabolic run-ups fueled by speculators looking to quickly earn big gains on their shares and calls. Some genuine capitulation in meme stocks might be necessary, too.”

The good news is that Demand trends still look healthy across many tech end-markets.

“Additionally, consumer and corporate spending mostly look good going into 2022, and yields for longer-dated Treasuries have actually dropped since Federal Reserve Chair Jerome Powell shared his market-churning comments about inflation and asset-purchase tapering on Tuesday,” Jhonsa said.

With semiconductor stocks falling after months of growth, which sector stocks are TheStreet’s trading experts tracking? Here’s a snapshot.

NVIDIA  (NVDA) - Get NVIDIA Corporation Report $291.14 5-Day Performance (-)12.79. 

While NVID took a tumble last week, the stock, like many sector favorites, has been on fire this year.

“The sector rally has been fueled by several catalysts: sustainable revenue growth with long-term opportunities in areas like games, EV and the metaverse; rich gross margins; and strong balance sheets,” said Bernard Zambonin and Daniel Martins on The Street.com.

NVDA has a consensus strong buy rating by Wall Street experts, based on 24 reports released in the past three months, Zambonin and Martins report. “The average price target on the stock is $356, which represents very modest 8% upside potential from current levels,” they noted.

The company announced Q3 results on November 17. Since then, analysts have reinforced their bullishness as the stock surged another 12% after earnings. Here’s what tech analysts are saying about Nvidia.

  • Bank of America analyst Vivek Arya raised the company’s price target to $375 from $340 after earnings, pointing at 14% upside potential. The analyst sees NVDA having a unique combination of “highly leverageable silicon, software, scale and systems expertise” that will continue to position it at the forefront of some of the largest and fastest growth markets in tech.

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  • Craig-Hallum analyst Richard Shannon also raised NVDA’s price target after earnings to $350 from $220, suggesting a modest gain opportunity of 6%. While he keeps a buy rating on the shares, he also suspects that the gaming cycle has hit its peak. Still, the analyst is raising estimates as nothing seems to be slowing NVIDIA in the data center.
  • Susquehanna analyst Christopher Rolland reiterated his buy recommendation on NVDA after earnings, forecasting a 9% upside potential. The analyst sees data centers as the star of the show, and he expects to see even more growth in 4Q.

Broadcom  (AVGO) - Get Broadcom Inc. Report $561.36 5-Day Performance (-)0.53%  and  Qualcomm   (QCOM) - Get Qualcomm Inc Report $173.38 5-Day Performance (-5.64%). 

Like Nvidia and other sector stocks, Broadcom and Qualcomm saw their shares fall last week, but both stocks look set for a quick rebound, Jhonsa noted.

“For all the good news that the chip industry has seen this year, many chip developers are valued like they're pure cyclical plays or close to it,” he said. “Forward P/Es below 20 still aren't hard to find for well-positioned chip developers with high margins and differentiated products, while memory makers sport forward P/Es below 10..”

While cyclicality and inventory builds/corrections remain facts of life for the chip industry, it's hard to ignore how many favorable trends are rolling in Broadcom and Qualcomm’s direction.

“Positive factors like rising cloud capex, EV adoption, IoT device proliferation and the growing computing, memory, analog and/or RF needs of various products are set to grow the pie over the course of this decade, even if we inevitably get some down-cycles along the way,” he added. “The long-term growth story with sector stocks like AVGO and QCOM is something very different than what exists for, say, the oil industry.”

Applied Materials  (AMAT) - Get Applied Materials, Inc. Report $144.18 5-Day Performance (-4.62%). 

On December 6, Citicorp tapped AMAT as its “top semiconductor pick” for 2022, followed by Lam Research  (LRCX) - Get Lam Research Corporation Report and Nvidia tracking close behind.

Citicorp cited the forward-looking semiconductor capital equipment sector as a big winner for the new year. The sector provides devices and components that companies leverage when producing computer chips. The investment firm cited technological innovation and some production incentives by the U.S. government as big reasons why the sector should generate $100 billion by 2025.

In such a bullish business environment, Applied Materials is a stand out in 2021. In fact, much of what applies to chip developers also holds for chip equipment makers, Jhonsa said.

“While up and down-cycles will continue impacting these companies, companies like AMAT stand to benefit this decade from both greater chip demand and (thanks in part to the incredible technical complexity of leading-edge manufacturing processes) greater industry capex-intensity,” he noted. “In addition, chip equipment sales will benefit over the next few years from efforts to address major supply shortages (particularly for trailing-edge processes) and to localize a larger portion of chip production.”

Perhaps surprisingly, quality chip equipment firms with sub-20 P/Es remain easy to find.

“Among these firms, I'm generally more partial to companies possessing relatively high gross margins (i.e., above 40%), as their earnings are typically less vulnerable to seeing massive declines during a down-cycle,” Jhonsa said.