Chip stocks have been on a volatile ride over the past year as investors have struggled to grapple with where exactly the semiconductor industry goes next.
The iShares PHLX Semiconductor ETF (NASDAQ:SOXX) rallied to all-time highs in mid-2018 as the industry broadly benefited from record cloud data-center spend, steady PC and smartphone growth, strong global auto growth and burgeoning demand in the AI and IoT end-markets. But, in late 2018, the SOXX ETF tumbled more than 25% on concerns that a slowing global economy was going killing all that robust demand, at the same time that supply was building across the whole sector.
Chip stocks shrugged off those fears in early 2019. As the global economy stabilized and recession fears disappeared, so did concerns regarding a slowdown in the semiconductor space. The SOXX ETF rallied back to all-time highs by late April 2019.
Then, another sell-off began. Trade tensions re-escalated. Recession fears came back. So did concerns surrounding global semi demand. Chip stocks sold off. They remain in selloff mode today. As of this writing, the SOXX ETF trades 15% off its April 2019 highs.
What’s next in this wild trip for chip stocks? Tough to say. But, it is easy to say that these stocks are broadly staring at big demand headwinds in 2019.
The PC and smartphone markets globally are flattening out, because everyone who wants either a computer or a smartphone, already has one. Global auto sales are dropping, especially in China, as consumers continue to express caution with the global economy slowing. Big tech companies are likewise acting more cautiously, and record data-center spend in 2018 is coming down in 2019.
Net net, the backdrop isn’t great for chip stocks right now. As such, investors should be cautious when considering an investment in any of the following chip stocks.
One of the riskiest chip stocks here and now is memory chip giant Micron (NASDAQ:MU), for the simple reason that the memory market is notoriously and violently cyclical.
In the memory market, it’s all about supply-demand fundamentals. When demand is high and supply is low, memory chip prices are high, and memory chip-makers make boat loads of profits. But, when demand is low and supply is high, memory chip prices are low, and memory chip-makers make no profits. Unfortunately, supply and demand in the memory market cycle often and dramatically. Eras of high demand and low supply are usually followed by eras of low demand and high supply. Just look at a chart of Micron’s profits or stock price over the past two decades.
Right now, we are in the process of the memory market going form high demand and low supply, and to rising supply and falling demand. The rising supply part seems to be moderating. But, the falling demand part isn’t moderating, mostly because rising geopolitical tensions continue to dilute memory chip demand. So long as that remains true, Micron’s profits will continue to drop, and so will MU stock.
As such, until the global memory market demand picture turns positive, MU stock will have a tough time staging a big turnaround.
One of the biggest semiconductor companies in the world, Broadcom (NASDAQ:AVGO), is not exempt from the macro factors diluting demand across the global semi industry.
Broadcom just reported solid second-quarter numbers, which broadly topped expectations and included double-digit revenue growth alongside healthy margin expansion. But, management also delivered a significantly sub-par, full-year guide thanks to what they are calling a “broad-based slowdown in the demand environment”. The culprit? Rising geopolitical uncertainties that are causing customers to reduce inventory levels.
So long as this slowdown persists, AVGO stock will have a tough time rallying. The stock isn’t particularly cheap here relative to its historical standard, at 12-times forward earnings today versus a five-year average forward multiple of 13. As such, you have a stock with not-so-good, go-forward fundamentals, trading at a historically average valuation.
That’s not a great combo. Until this stock gets cheaper — or until the fundamentals improve — AVGO stock will likely fail to rally.
The story at Qualcomm (NASDAQ:QCOM) is riddled with question marks. All those question marks against the backdrop of a depressed semi market backdrop could keep QCOM stock stuck in neutral for the foreseeable future.
Qualcomm scored a huge win recently, when Apple settled with the chip giant, paid the company a huge lump sum royalty payment and came back on as a Qualcomm customer. Shortly after that, though, it was ruled that Qualcomm’s patent royalty practices violated U.S. antitrust law. That’s a big deal, since most of Qualcomm’s profits come from the high-margin licensing business. The ruling broadly implies that the licensing business is going to have to change, and in a way that will probably dilute profits.
Consequently, investors are stuck asking themselves exactly what Qualcomm’s licensing business will look like in a few years. The truth is, no one knows. Investors don’t like uncertainty. They especially don’t like uncertainty when it comes against the backdrop of a depressed macro semi market struggling with falling demand and geopolitical tensions.
To be sure, none of these issues will last for QCOM stock. The stock does look like a good long-term buy here, since long-term fundamentals are healthy. But, near-term uncertainty will ultimately keep QCOM stock depressed for the foreseeable future.
Advanced Micro Devices (AMD)
The story at Advanced Micro Devices (NASDAQ:AMD) is a bit different than the story supporting other chip stocks at the current moment.
Specifically, the story at AMD is actually much better. AMD has taken an innovation lead over competitor Intel (NASDAQ:INTC) in the CPU market, and it has leveraged that innovation lead to rapidly grow market share over the past several quarters. This market share expansion has driven out-sized revenue growth and margin expansion, which has produced robust profit growth. This market share expansion narrative projects to persist for the foreseeable future, meaning AMD should continue to report pretty good numbers.
But, this market share expansion is happening in a market that’s struggling with falling demand. At the core of this falling demand is reduced cloud data-center spend from the titans of tech. This spend reduction is a temporary phenomena. But, so long as it lasts, AMD’s numbers won’t be as good as they need to be, to support the stock’s near 50-times forward multiple.
As such, while the story at AMD is better than the story for other chip stocks, the stock is not exempt from macro demand headwinds, and those macro demand headwinds could ultimately hinder the richly valued AMD stock from rallying much further.
When it comes to shares of GPU giant Nvidia (NASDAQ:NVDA), you have a situation of near-term pain and long-term gain.
In the near term, Nvidia will continue to struggle with inventory and pricing issues as cloud data-center spend moderates against the backdrop of a slowing global economy and rising geopolitical tensions. So long as these inventory and pricing issues remain, revenue growth at Nvidia will remain tepid, while margins will remain under pressure. NVDA stock will struggle to rally.
In the long term, Nvidia will work through these inventory and pricing issues since secular tailwinds support robust demand for the next several years in the data and AI-related markets that Nvidia services. Once those issues are cleared, big revenue growth will come back into the picture, as will margin expansion. This combination will power healthy profit growth, and that healthy profit growth will drive NVDA stock higher.
Net net, the situation at Nvidia is one defined by near-term pain and long-term gain. Thus, depending on your time horizon, NVDA stock is either an avoid here, or a good buy.
Texas Instruments (TXN)
Over at semiconductor giant Texas Instruments (NASDAQ:TXN), you have a chip stock that has worrisome exposure to the slowing global auto market.
Texas Instruments views the industrial and auto markets as the best markets in the semiconductor space, and as such, has focused their resources on maximizing exposure to those markets. Over 50% of revenues now come from the auto and industrial markets. Four to five years ago, that number hovered around 40%.
The problem here is that the auto market is fading globally. China auto sales have been tumbling for several months. The U.S. auto market has been weak lately, even with low interest rates. The European auto market is seeing declines for the first time since 2013. Broadly, after several years of red-hot growth, the global auto market is in retreat, and that’s not good news for Texas Instruments.
At the same time, TXN stock isn’t cheap for a semi stock, trading at 20-times forward earnings. That combination of a not-cheap valuation and mounting headwinds in the company’s most important market, ultimately means that TXN stock may not have much room for further upside in the foreseeable future.
As of this writing, Luke Lango was long QCOM and INTC.