A combination of a seasonal lull for chip makers, rising earnings estimates and a price decline could make for a good setup
So far this year, the PHLX Semiconductor Index has increased 8.7% (with dividends reinvested), but it has declined 7.7% in April. Meanwhile, shares of industry star Nvidia Inc. have declined 12% this month. Then again, Nvidia's stock has risen 61% so far in 2024, after more than tripling in 2023.
So what are investors to think of the recent action in the semiconductor space? In the Thursday Need to Know column, Jamie Chisholm shared ideas from equity strategists at Bank of America who had some encouraging words: Semiconductor stocks typically pull back in April and rally in May.
So even if you are a long-term investor rather than a short-term trader, you may be looking at an opportunity to play the semiconductor space broadly, or to select individual companies in the space. One easy way to invest in the industry is through the iShares Semiconductor ETF SOXX, which tracks the performance of the PHLX Semiconductor Index SOX by holding all 30 of its stocks. This approach is weighted by market capitalization, which means that Nvidia $(NVDA)$ makes up 8.4% of the SOXX portfolio, according to data provided by FactSet.
Is the semiconductor group trading high, relative to expected earnings?
Now you might be wondering about the relative valuations of semiconductor stocks. The PHLX Semiconductor Index trades at a forward price-to-earnings ratio of 27.8, which is up from 24.3 at the end of last year, but down from a peak of 33.3 on March 7, according to FactSet. The forward P/E is based on current prices and rolling 12-month earnings-per-share estimates for the 30 component stocks, weighted by market capitalization.
In comparison, the forward P/E for the S&P 500 SPX is 20.2, which is up from 19.6 at the end of last year, but down from a 2024 high of 21.1 on March 28.
Here are current and average valuations for the two indexes:
And here are current valuations relative to the averages:
Both indexes are trading above the longer-term averages, but this phenomenon is more extreme for the semiconductor group.
Here's a comparison of total returns for SOXX and for the SPDER S&P 500 ETF Trust:
Looking at the 15-year and 20-year returns, the semiconductor group was hit even harder during the 2008/early 2009 financial crisis than the broad market was.
Here are average annual returns:
And here is a comparison of weighted five-year compound annual growth rates (CAGR) for revenue and EPS for the two indexes through 2023. The numbers are adjusted by FactSet for companies whose fiscal years don't match the calendar.
Sector Five-year sales CAGR through 2023 Five-year EPS CAGR through 2023 PHLX Semiconductor Index 7.5% 7.1% S&P 500 6.4% 6.6% Source: FactSet
Now let's look ahead at projected CAGR for the two indexes:
One might argue that you get what you pay for. The semiconductor group trades at a high P/E relative to the S&P 500, but it has grown sales and earnings more quickly than the broad index has over the past five years.
And the semiconductor group's outperformance by these measures is expected to accelerate.
Screening the SOXX 30
Let's begin by looking at forward P/E ratios for the entire SOXX 30 group of stocks and compare those to the ratios one year ago, while also showing one-year price changes, this time excluding dividends.
The list is ranked by how much the forward P/E has changed over the past year, ascending:
Nvidia’s forward P/E has declined the most over the past year, even as its share price has nearly tripled. Its forward P/E has declined because rolling 12-month EPS estimates have increased more rapidly than the share price has. And Nvidia’s stock’s current P/E is 76% of its five-year average P/E. It is one of only seven stocks on the list trading below their five-year averages by this measure.
Micron Technology Inc. MU is near the bottom of the list despite a relatively low forward P/E because a year ago there was no forward P/E ratio; at that time the company’s 12-month EPS estimate was negative.
Here’s the list again, this time sorted by projected sales CAGR from 2023 through 2025, based on consensus estimates among analysts polled by FactSet, adjusted by the data provider for companies whose fiscal years don’t match the calendar.
As always, you should do your own research to form your own opinion before making any investment. One way to begin that process is to click on the tickers.
The projected EPS growth rates are market “N/A” if EPS were negative during calendar 2023.
If you believe Nvidia is still on the early part of its growth trajectory, as it dominates the market for graphics processing units being installed by data centers to support corporate clients’ development of artificial intelligence technology, this might be a good entry point for the stock.
