Semiconductors play a key role in enabling both physical form technology, such as lidar sensors or phones, and digital media technology like online streaming or cloud services. That’s largely why investors find semiconductor stocks appealing — they essentially make our high-tech lifestyles possible and will be a necessary component within countless technological evolutions to come.
Before diving into the investment opportunity in the semiconductor industry, let’s first acknowledge a few distinctions between the various businesses within the industry. This will help us understand how these companies operate and more clearly demonstrate semiconductor companies’ greater influence on the world.
There are three core types of businesses within the semiconductor industry:
- Fabless semiconductor companies
- Integrated device manufactures
Fabless semiconductor companies include tech behemoths like Nvidia (NASDAQ:NVDA), Advanced Micro Devices (NASDAQ:AMD) and Qualcomm (NASDAQ:QCOM). These companies design the technology and sell the hardware; however, they outsource the actual production of the hardware to foundries.
Semiconductor foundries like Taiwan Semiconductor (NYSE:TSM) specialize in the production of semiconductor hardware at fabrication plants. Meanwhile, some companies like Intel (NYSE:INTC) design, produce and sell their semiconductor products. Intel has in-house semiconductor fabrication plants, which allows it to conduct business differently than fabless companies. Such companies are called integrated device manufacturers (IDMs).
Regardless of these distinctions, these industry giants all play a key role in the broader ecosystem of technology. For example, both Sony (NYSE:SNE) and Microsoft (NASDAQ:MSFT) rely on AMD to design hardware for their videogame consoles, while AMD relies on TSM to produce it.
Given the industry’s far-reaching impact on tech as a whole, focusing your investments on semiconductor stocks can prove quite lucrative. But there are some positives and negatives you must consider first in order to make an informed decision.
How Did the Pandemic Influence Semiconductor Stocks?
First, let’s take a closer look at how the pandemic changed the semiconductor industry. From there, we can identify how it might change in the years ahead.
The pandemic’s impact on tech — and by extension, semiconductor stocks — was particularly profound.
Tech has almost always been viewed as a growth sector in the market. All of the stocks in the FAANG group are tech plays, for example. When the market panicked during March 2020, investors suddenly had to rethink their portfolios. This led to an incredible bull run in some tech stocks.
Apple rose over 100% during the pandemic. Fintech play PayPal (NASDAQ:PYPL) at one point crossed over 150%. Semiconductor darling Nvidia racked up over 300% in two years, topping over 400% at its highest point. Tech was the hottest it had been in years.
At the center of the pandemic tech catalyst was a quick-growing need for semiconductors. New demand for streaming, e-commerce and telework created a massive new growth opportunity within the tech sector.
Growth catalysts that were anticipated to occur over several years peaked much earlier for many tech companies. Semiconductor stocks also enjoyed impressive gains as the broader tech industry catapulted to new heights. However, despite seeing record sales across the board, many chip manufacturers didn’t have the infrastructure in place to handle the increased demand.
In fact, the subsequent semiconductor shortage has affected almost 170 industries according to Yahoo Finance.
New Expectations With Semiconductor Investing
The demand for semiconductors from these new (and existing) tech branches — streaming, gaming, e-commerce, etc. — won’t simply go away. That’s true even as the pandemic cools down.
While the pandemic-induced growth catalyst will likely slow down for tech as whole, its impact will not dissipate. For example, Nvidia reported on its Q3, 2022 financial results that revenue from its data center and gaming segments grew 55% and 42%, respectively.
But there are other long-term catalysts to consider, such as the increased interest in environmental, social and governance (ESG) investing. This is particularly true when it comes to green energy, a facet of which semiconductor companies play a key role.
When President Joe Biden won the 2020 presidential election, a new wave of bullish sentiment for electric vehicle (EVs) stocks sprung up. The idea here being that Biden would prioritize legislation centered around green energy. EV manufacturers rely heavily upon semiconductors for their vehicles. According to CNBC, the semiconductor shortage cost the automotive industry $210 billion in 2021 alone. Clearly, increased demand for EVs will also prove to be yet another catalyst beyond the pandemic’s influence on tech.
In other words, while the pandemic catalyst will eventually fade, it will grow the industries that rely on semiconductor manufacturing. Many of these companies are still growing into their valuations. Semiconductor manufacturers have a growing base of customers, with many of their newest customers being emerging industries that will one day become “the new big thing” in the market.
Potential Risks Ahead in Semiconductor Investing
While semiconductor stocks have many reasons to be valued high, the pandemic caused a never-before-seen shift in how investors look at the market. Tech is almost always a growth sector, but the past two years have been an outlier compared to prior growth. With inflationary concerns and Federal Reserve plans to increase interest rates, the market is facing a decline.
This will undoubtedly impact tech stocks (and likely semiconductor stocks too). Even while the shortage persists and business booms, the market doesn’t always follow along with the fundamentals. Investors have to consider their risk appetite, and when the market’s unwieldy, that means moving assets out of growth sectors into more defensive positions, such as dividend stocks, blue-chips, consumer staples or banking stocks.
While semiconductors seem like a sure bet now, they do carry a fair amount of risk that’s worth taking into account.
Likewise, there’s a lot of hype baked into the tech sector as well. Analysts have constantly questioned whether the current valuations for EV and green energy stocks are justified. Beyond a market correction, there are serious questions about the “true value” of some of these emerging industries. It’s likely true that they will be great investing themes for years to come. But they may be due for a steeper correction in the short term to bring them more in line with their fundamental numbers.
For example, CNBC reported Rivian (NASDAQ:RIVN) and Lucid Motors (NASDAQ:LCID) are worth a combined $150 billion, despite having little to no revenue. Should the bubble burst in these industries, it would likely impact the demand and sentiment for semiconductors too. They are all tied together in the same sailing (or sinking) ship.
Are Semiconductor Stocks Worth Investing In?
The semiconductor industry’s revenue is estimated to grow by 8.8% this year. This seems paltry compared to 2021’s impressive 25.6% gain, but 2021 was largely dependent on the Covid-19 pandemic increasing demand. The semiconductor industry should be expected to continue growing in years to come, although the current climate is admittedly favorable for it as it navigates through a pandemic-induced tailwind. Growth should slow as the world recovers.
That’s a long-winded way of saying: yes, semiconductor stocks are worth investing in today. But, like all things investing, it’s not an open and shut book.
Semiconductors exist in almost all technology — they’re needed for over 150 industries. Couple that into the high-growth tech sector and you’ll see high returns. Their necessity means there will always be demand, while their growth prospects are tied with the prospects of growing tech companies that will one day rule the market.
However, it’s a double-edged sword. The tendency for tech to be a growth sector only means that when the market is valued too highly, crashes are likely and fast.
This is doubled by the pandemic catalyst. The pandemic catapulted semiconductor companies to the forefront of the market. It has been a short-term boon over the past few years. However, the pandemic will one day officially end. When it does, semiconductor stocks will likely see more modest pricing as demand returns to normal.
Put into the context of long-term investing, semiconductors are a tempting investment. They’re absolutely needed for most emerging technology today and their products are needed across a range of different industries. It’s hard to fully encompass the industries that use them, which makes their business incredibly diverse.
Ultimately, the industry is projected to grow, and as new emerging industries grow, semiconductor stocks will likely grow with them.
Top Semiconductor Stocks to Watch
On the date of publication, Peter Olin did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Peter Olin is an assistant editor at InvestorPlace.com.