Every tech investor knows Moore’s Law, the idea that semiconductor chip density can double every year or two, exponentially expanding computing power in the process.
But few understand Moore’s Second Law, which I’ve been writing about for decades. As chips get more complex, the start-up costs associated with manufacturing increase dramatically.
What the September 3 market meltdown showed was that we’ve gone beyond what private markets can do to fight back. Semiconductor stocks were at the heart of the fall, and there could be more to come. They’re now dependent on state actions.
We’re barreling towards the upper physical limits of Moore’s Law, when the distance between circuits approaches the width of light. And the extreme cost of this makes chip production a question of national security.
Thus, the technological Cold War the Trump Administration initiated with China has bitten the semiconductor business in the behind. That makes this sector volatile, but potentially lucrative.
Here are 7 semiconductor stocks suffering under Moore’s second law:
- Taiwan Semiconductor (NYSE:TSM)
- Apple (NASDAQ:AAPL)
- Intel (NYSE:INTC)
- Nvidia (NASDAQ:NVDA)
- Advanced Micro Devices (NASDAQ:AMD)
- Microchip Technology (NASDAQ:MCHP)
- Qualcomm (NASDAQ:QCOM)
China is willing to go to any lengths to become independent in semiconductors. They will use money, they will use espionage, they will even threaten war over it, because the company that already won the chip production wars sits squarely in the center of the fight.
Taiwan Semiconductor (TSM): The Most Important Company in the World
It’s no exaggeration to call Taiwan Semiconductor (NYSE:TSM) the most important company in the world.
While Intel (NASDAQ:INTC) failed to master the 7 nanometer chip process, TSM has delivered over 1 billion 7 nm chips. Further, the company is seeing lower defect rates on 5 nm than it did at this point in its 7 nm development. The key is in its mastery of the arcane Extreme Ultra Violet (EUV) process, where it has half the world’s installed base and 60% of its production.
Over the last year TSM stock is up 88%, and most of these gains have come in the short time since July.
Taiwan Semiconductor’s impending monopoly, however, has turned chip production into a global political battle. It’s one China, which considers Taiwan a breakaway province, does not intend to lose.
China’s state-owned semiconductor makers have snatched up 100 of TSM’s top engineers with lavish pay packages. State-based hackers have also infiltrated Taiwan Semiconductor computers, seeking company secrets as well as those of its customers.
China’s urgency on this matter only increased when the Trump Administration forbade TSMC from supplying Huawei, the Chinese communications equipment firm. This could deal a deathblow to the communications firm. The Administration also moved to ban WeChat, a key method for Chinese diaspora in America to contact relatives and friends back home. This signaled to China that it’s in a war for the survival of its tech industry and thus it has doubled down in its efforts against Taiwan.
That’s why the market is tanking, led by the semiconductors. Taiwan’s plants are still in Taiwan.
Taiwan Semiconductor is working with the Trump Administration to build a big new plant in Chandler, Arizona. But that won’t be finished for years.
Meanwhile, the global tension is ratcheting up, with the entire semiconductor industry now caught in the middle.
Apple (AAPL): Enough Cash to Make a Difference
The only American company that could reasonably compete against state-owned actors is Apple (NASDAQ:AAPL). Its 2019 run-up was driven by its cloud-based services business. The 2020 rally has been driven by its ambitions in semiconductors.
Apple Silicon makes all sorts of sense. Apple gets its chips fabricated by TSMC, like most big American semiconductor makers. Apple’s business is one reason TSMC is negotiating to build a facility near Phoenix, Arizona. Apple’s business has helped fuel the Taiwanese company’s expansion.
This close relationship puts Apple in front for all TSMC breakthroughs, like the 5 nm fabrication planned for 2021. Apple also has the money to create designs that its rivals, in both processing and graphics, can’t match.
By designing its own chips, Apple increases margins and controls its designs. Instead of just competing with Microsoft (NASDAQ:MSFT) based PCs on price-performance, it can make hardware to compete with Alphabet (NASDAQ:GOOGL) Chromebooks.
Apple is also worth 7.5 times more than Nvidia (NASDAQ:NVDA). The same is true of Qualcomm (NASDAQ:QCOM), with which Apple has had a long-running legal war. Qualcomm reportedly developed its latest Snapdragon processor, which includes a modem, specifically around Apple’s specifications.
But Apple doesn’t forget. It plans to start making its own modems by 2022, maybe 2023. These would be integrated into processing chips, as with Snapdragon.
Apple’s move into silicon is the biggest semiconductor story of the year, the biggest Apple story, and perhaps the biggest global business story. What Apple Silicon promises for Apple is lower prices down the road and higher margins.
What it promises for the semiconductor industry is a deep-pocketed company that could, in a pinch, acquire Taiwan Semiconductor and go toe-to-toe with China’s government investments.
That’s why I recommend buying Apple on any dip.
Intel (INTC): Fall of the House of Moore
Seen in isolation, Intel’s (NASDAQ:INTC) most recent earnings were spectacular. Non-GAAP earnings of $1.23 per share, 16% ahead of last year, on revenue of $19.7 billion. Add to that $10.6 billion in free cash flow and $2.8 billion paid out in dividends.
Yet shares that traded at $61 just a week prior, opened to 20% losses after earnings. The reason for that was found near the end of CEO Robert Swan’s remarks: “We are seeing an approximate six-month shift in our 7nm-based CPU product timing relative to prior expectations.”
That’s a mealy-mouthed way of saying Intel can’t get its latest chip production technology working.
“We have also invested in contingency plans to hedge against further schedule uncertainty,” he added. That means Intel is now going to buy production from its manufacturing rival, Taiwan Semiconductor (NYSE:TSM). It would be like Ford (NYSE:F) CEO Jim Hackett saying his new pick-up would be made by Toyota Motors (NYSE:TM)
It wasn’t just what Swan said, but the way he said it that stunned analysts. He didn’t state it like a leader. He hid it like a bureaucrat. Analysts from Jim Cramer to Susquehanna subsequently threw in the towel.
Intel hasn’t had an entrepreneur at the helm since the late Andy Grove retired in 1998. His successor, Craig Barrett, is even listed in Intel’s official history as “transitional.”
Meanwhile, Taiwan-born Jensen Huang founded Nvidia (NASDAQ:NVDA) in 1993. Advanced Micro Devices (NASDAQ:AMD) recruited Taiwan-born Dr. Lisa Su and made her CEO in 2014. Both are entrepreneurial. Both are brilliant engineers. If Intel still wants to compete at the sharp end of the semiconductor space, it needs to find a leader like that.
It’s what I’ve called “Moore’s Third Law of Management.” Accelerating change concentrates power, and responsibility, at the top of a company. Without an upgrade there, Intel’s future is in low-grade commodity chips, not at high-end of the market.
Of course, there’s still money to be made on the low-end too. Which is why I recently bought some Intel stock for my own portfolio.
Nvidia (NVDA): King of the Chip Hill
The success of Nvidia (NASDAQ:NVDA) is proof that software has become hardware. Nvidia’s success is such that it is handing out raises rather than pay cuts as the COVID-19 pandemic rages across the U.S.
Nvidia doesn’t make chips, it designs them. Its graphics processors are the fastest in the world. They were first built for game machines, but that’s no longer Nvidia’s biggest market.
That would be the cloud.
Nvidia’s graphics processors should be called Artificial Intelligence processors. They’re at the heart of today’s cloud computing upgrades because Nvidia also writes software that optimizes its hardware. That software is being used by all major cloud platforms, in both the U.S. and China.
This has allowed gaming, Nvidia’s original niche, to finally move decisively to the cloud. It’s creating new applications in what I call the Machine Internet. And it’s giving Nvidia what analysts call a “runway,” long-term predictable growth.
That’s why, back when the virus was killing markets in March, I suggested investors buy into Nvidia stock. Over half the company’s 38 analysts put it on their “buy” lists, according to Yahoo Finance. It’s even more popular at Tipranks, where 26 of 31 say “buy.”
Nvidia has been consistently beating analyst earnings estimates, most recently by 22 cents per share or 13%. The consensus number on its April quarter was $1.36 per share on revenue of $3 billion. It blew past that, with $1.47 per share of earnings on $3.1 billion of revenue.
That being said, te party is far from over for Nvidia stock. Cloud gaming, and the rise of the Machine Internet, should keep sales strong. This is true even as Cloud Czars like Microsoft (NASDAQ:MSFT), Amazon (NASDAQ:AMZN) and Alphabet (NASDAQ:GOOGL) invest in their own graphics chips, thanks to Nvidia’s software.
Software is the key point. In the 21st century, hardware is software. Nvidia, like most chip companies is “fab-less,” creating chip designs made by others. It’s a cloud software house disguised as a chip company.
That makes NVDA a core holding for any long-term investor.
Advanced Micro Devices (AMD): Great Company, Overvalued Stock
I liked it at $20, and even $40. It’s is a great company and Su’s a great leader. AMD makes faster microprocessors than Intel (NASDAQ:INTC), and they’re competitive in graphics with Nvidia (NASDAQ:NVDA).
But at $88 per share, I said sell. The stock dropped nearly 10% before I could get my story published.
The call was based on fundamentals: before it fell the stock was selling at nearly 16 times annual revenue. Its market cap was $106 billion on 2019 sales of just $6.7 billion. And we still can’t talk dividend, as there isn’t any.
AMD’s secret sauce is Dr. Su. She had already proven herself at Texas Instruments (NYSE:TXN), International Business Machines (NYSE:IBM) and Freescale, now part of NXP Semiconductor (NASDAQ:NXPI), before being recruited by AMD in 2012. She holds a Ph.D from MIT, where she worked on silicon-on-insulator technology, which creates a third dimension for chip designers. And she’s still only 50.
Under Dr. Su, AMD sales have nearly doubled and net income has increased more than fourfold. The company has overtaken Intel on the high-end of the processor market, something long-time CEO Jerry Sanders could only dream of. Su was also well-positioned, as her predecessor Rory Read had already done some hard work cutting costs and pioneering new architectures for AMD before handing her the baton.
AMD had more than 15% of the PCmarket in 2019. It has about 25% of the graphics processor market. Gains should continue in the former, and the latter segment is quickly growing as data centers upgrade.
There’s a limit to the value of any company. AMD briefly exceeded that limit; expect it to fall, but also expect it to bounce back.
Microchip Technology (MCHP): Life Beyond Moore’s Law
There is life beyond Moore’s Law. The power of modern chips, and their dependence on software, means you don’t need the best fabrication to make money.
Privately-held Global Foundries, which decided years ago not to follow its rivals onto the bleeding edge, still makes money. This means there’s still life for companies like Microchip Technology (NASDAQ:MCHP).
MCHP is a company based near Phoenix, Arizona, that makes microcontrollers. For years, these devices were hidden inside hard disk drives. Now they’re behind the scenes everywhere, controlling your WiFi, managing power, acting as interfaces.
You don’t buy these products directly; rather, they’re component parts of other products. But it’s pretty good business, totaling $5.3 billion last year.
Microchip depends on other product manufacturers to buy its product. Sales for the 2020 fiscal year, ending in March, were lower than they were over the same timeframe in 2019. Those figures should be lower still for the remainder of the year. Yet to read the financial press, MCHP is a hot stock.
There are two reasons for this.
First, it was hit hard by the pandemic. The value of shares was cut in half, and it’s only just returning to those heights.
Second, management has done a good job massaging expectations. The company has beaten earnings estimates the past three quarters. It should do so again when it reports November 3. Expectations are for $1.26 billion in revenue and $1.27/share of earnings.
MCHP has plants around the western U.S. But it does a lot of its testing and final assembly work in the Far East, where the devices utilizing its products are made.
In other words, its business model is built on free trade. As a result, it hasn’t been growing since the $1.4 billion spurt that came with the 2018 acquisition of Microsemi for $10.3 billion. That came just two years after it bought Atmel for $3.4 billion.
While MCHP is fully-valued based on its current book of business, it deserves a second look from long-term investors.
That’s because its product line has put it directly into the crosshairs of what I call the Machine Internet, also known as the Internet of Things.
This isn’t going to all happen at once. Cars aren’t going to suddenly become autonomous. Instead, they’ll add features, as will the road system. Houses aren’t going to suddenly become ultra-smart. There will just be more ceiling fans, heating systems, stoves and entertainment devices supporting Alexa every year. Your fitness band will give you better alerts in emergencies and eventually become a health monitor.
It’s like the cloud. You didn’t notice it in 2010. Now it’s embedded in your life. MCHP will make the cloud into a ubiquitous fog, offering interactivity you don’t even notice. Best of all, MCHP doesn’t need to be on the leading edge of chip fabrication to deliver value. Your ceiling fan may need a microcontroller, but it doesn’t need a super-fast one.
Look at this as a decade-long play. The Machine Internet is coming. The cloud is becoming omnipresent in a good way. Each time it touches you, a Microchip product or three will be helping in the background. Those sales add up quickly.
Qualcomm (QCOM): Recovering From COVID-19
There’s another way to chip success, beyond having the best fabrication or the best software. That’s controlling the patents and copyrights underneath the software, creating a monopoly. Qualcomm (NASDAQ:QCOM) has done just that.
Qualcomm fought a decade-long war to tie its copyrights to its chip designs. Without buying the patents, you can’t get the chips, and you can’t make your own without those rights, either.
Thus, a lot of the recent news involving Qualcomm comes from courts. The company lost its case on this point last year, but an Appeals Court overturned that decision in August. The decision removed the final legal cloud hanging over Qualcomm’s dreams of market dominance.
Qualcomm’s 62 cent per share dividend, supported by ample cash and earnings, is another reason to buy the stock.
Qualcomm won 36% of the smartphone Application Processor market last year. When looking just at those processors including Artificial Intelligence (AI) support, a market that grew 45% in 2019, Qualcomm’s share rose to 51%.
While the roll-out of 5G services has been delayed by the virus, that transition is still moving ahead. The 5G wave will bring intelligence to everything from traffic lights to heart monitors.
Vast new swaths of frequency will be used for Internet-based applications, in both higher and lower frequency bands. Qualcomm is going to get a big share of that money. Qualcomm has already released code support for the silicon it intends to sell.
Qualcomm even has the Chinese market on lock. Having won rights to the China market, it is now working with companies there on things like smart displays. These should keep it on the cutting edge of computing through the decade.
Even without cutting-edge fabrication, there is plenty of money in 5G and the Machine Internet for Qualcomm to prosper.
Dana Blankenhorn has been a financial and technology journalist since 1978. His latest book is Technology’s Big Bang: Yesterday, Today and Tomorrow with Moore’s Law, essays on technology available at the Amazon Kindle store. Write him at firstname.lastname@example.org or follow him on Twitter at @danablankenhorn. As of this writing he owned shares in, AMZN, TSM, AAPL, QCOM, INTC, MSFT and NVDA.