Semiconductor stocks have gotten pounded—and some investors see a chance to buy the dip.
Despite concerns that have sunk chip stocks, demand for semiconductors doesn’t look set to drop.
We’re familiar with the pounding part. The iShares Semiconductor ETF has dropped 8.1% from July 10 through Thursday’s close, while Nvidia stock has fallen 10%.
Pushing them down: A weaker-than-expected inflation print that investors bet would give the Federal Reserve cover to cut interest rates in September; comments by former President Donald Trump, who said that he would force Taiwan to pay for the protection it receives from the U.S.; and news this week that the Biden Administration floated the possibility of stepped-up restrictions on certain semiconductor equipment makers’ sales to China.
Still, enough of the theoretical damage to semiconductor companies’ profits might be reflected in the stocks. For starters, Nvidia, AMD, and Broadcom got about 20% of their total sales in the past 12 months from China, according to our calculations of FactSet data. Profit margins would also take a hit because of fixed costs that management won’t be able to trim. As a result, earnings could drop by some double-digit percentage in a worst-case scenario. But that’s the worst-case scenario, and a chunk of it is already reflected in the stocks.
Even if heavier restrictions are imposed on sales to China, companies can mitigate the shortfall. Much of the chip sales to China don’t end up inside Chinese consumer devices, explains Wedbush analyst Matthew Bryson. They’re shipments of chips to Chinese factories that are then transported to other countries. If more China restrictions are imposed, chip makers could redirect sales away from China, Bryson explains, and into a country such as Vietnam, before the products are sent around the world.
What’s more, sales are expected to grow for years to come, and that should be the case even with a reduced China. The current consensus is for these three firms to grow top-line figures by a double-digit annual percentage for at least the next three years after this year. The data center business is growing the fastest out of all segments because data centers need more chips to power the artificial intelligence component of new cloud offerings provided by software companies such as Microsoft, Meta Platforms, and Alphabet.
“Those trends are real and they’re happening,” says Doug Bycoff, chief investment officer of the Bycoff Group.
Margins are a slight question mark. AMD’s entrance into the data center AI chip picture could reduce chip prices for Nvidia, but operating margins for AMD and Broadcom are expected to rise over the next three years. For AMD, the data center will become a larger part of its entire business—and it carries higher margins because data center chip prices are extremely high. The result is that analysts expect greater than 20% earnings per share growth for the three companies over the next few years.
Ultimately, these factors should make the falling chip stocks attractive—at the right price. Some investors seemed willing to bet that the price was right for Nvidia, at least. Its stock gained 2.8% on Thursday, while the iShares Semiconductor ETF closed up 0.3%.
Time will tell if they got it right.
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