Semiconductor stocks, high-fliers in the bull market, have been hit hard lately, and analysts are expecting the industry’s sales and earnings growth to slow to a crawl in 2019.
Long-term investors already know they need to be patient with these stocks because of their volatility. But there may be even more pain ahead, which is why investors ought to focus on quality and efficiency, rather than seeking out companies with the fastest sales growth.
The S&P 500 Index
declined 9.3% from the end of September through Dec. 7 (including reinvested dividends), as its heavy market-capitalization weighting to big tech companies took a toll. Here’s how the so-called FAANG group of technology stocks performed during the same period:
So there’s been a major drag from the FAANG group, all of which have significantly underperformed the index.
Digging further, the S&P 500 information-technology sector was down 14% from Sept. 28 through Dec. 7, and the semiconductor and semiconductor manufacturer subsector fared even worse, with a 17% decline.
Investors who have remained dedicated to semiconductor stocks have made a lot of money over recent years. However, they have been required to tolerate much greater volatility over many short periods. To take a broader look at the chip makers, let’s compare the five-year performance of the PHLX Semiconductor Index
to the S&P 500 information-technology sector and the broader S&P 500, through Dec. 7:
You can see that the PHLX Semiconductor Index has shined. Its elevated volatility is illustrated even better with a three-year chart:
An easy way to invest in semiconductor manufacturers and associated companies as a group is the iShares PHLX Semiconductor ETF
which mirrors its namesake index,with annual expenses of 0.47% of assets under management.
One might look back and think semiconductor companies have been an obvious investment play, with the ubiquity of (upgraded) smartphones and the increase in the number and variety of devices and appliances making use of microchips.
But it certainly hasn’t been fun for investors to “hang in there” when the industry takes its more-than-occasional lumps. For example, during 2017, the iShares PHLX Semiconductor ETF returned 40%. But there was a decline of 10% from the close on June 8, 2017, through the close on July 3, 2017, and an 8% decline between Nov. 24, 2017, and Dec. 4, 2017.
There’s also the possibility that semiconductor stocks have further to fall before investors feel comfortable jumping back in. During 2018, it has been easy for investors to get used to wonderful comparisons of quarterly results to those of a year earlier. But for the past three earnings seasons, the new numbers have reflected the boost to the bottom line from the cut in the federal corporate income tax rate to 21% from 35%. This support for stocks, springing in part form jubilant headlines during earnings season, will disappear next year.
Here are comparisons of adjusted and estimated growth rates for the PHLX Semiconductor Index, the S&P 500 information-technology sector and the entire S&P 500.
|Estimated increase in sales|
|PHLX Semiconductor Index||15.0%||17.6%||3.8%||6.6%|
|S&P 500 information technology sector||8.7%||10.6%||4.7%||5.8%|
|S&P 500 Index||6.3%||9.6%||5.5%||4.6%|
And now, earnings per share:
|Estimated increase in earnings per share|
|PHLX Semiconductor Index||36.7%||27.7%||2.7%||10.4%|
|S&P 500 information technology sector||21.1%||18.8%||7.9%||10.7%|
|S&P 500 Index||11.5%||22.4%||8.7%||10.5%|
This is a fascinating set of numbers, and, if the sell-side analysts polled by FactSet are anywhere close to being accurate, dismal for semiconductor industry sales and earnings in 2019. The 2018 earnings numbers are boosted by the tax cuts, so U.S. companies’ earnings growth expectations have to come back to Earth. But the expected slowdown in sales growth shows that the forces hurting demand for Apple’s iPhone signal a trend across the industry. A comparison of the 2017 figures and 2019 estimates is of particular concern, as the 2017 numbers weren’t juiced by tax cuts.
A focus on earnings quality
The long outperformance for semiconductor stocks may continue over the next multi-year period. But during recent years, even with sales and earnings rising at a steady clip, the ride has been a rough one. So it may be best to focus on quality.
One way to measure the quality of a company’s management team is to consider how good a job it does deploying the money it raises. The Shareholder Forum provides free calculations of publicly traded U.S. companies’ returns on corporate capital (ROCC).
ROCC is similar to return on invested capital (ROIC), but definitions of ROIC vary. ROCC is calculated the same way for nearly every company that’s publicly traded in the U.S., using annual data filed with the Securities and Exchange Commission: Net income plus interest expense and income taxes, divided by the ending balance of total assets less total liabilities other than interest-bearing debt. (Some companies that are publicly traded in the U.S. but have foreign domiciles don’t file annual 10-K reports with the SEC, and for those ROCC is not available.)
Each company’s ROCC is compared to its industry competitors, based on the company’s Standard Industrial Classification (SIC), which also comes from SEC filings. The comparisons are available for free here. A company’s ROCC is not simply compared to the average ROCC for its SIC group. Instead, a calculation is made for the aggregated assets and income data for the entire SIC group, excluding for the subject company. This means that the industry ROCCs for two companies in the same group may be different.
The PHLX Semiconductor Index is made up of 30 companies, and ROCC numbers are available for 26 of them. Here are those 26, sorted by their five-year average ROCC through fiscal 2017:
|Company||Ticker||SIC Industry||Five-year avg. annual ROCC||Five-year average ROCC – industry competitors||Total return – 5 years|
|Texas Instruments Inc.||Semiconductors and Related Devices||28.8%||11.1%||142%|
|Skyworks Solutions Inc.||Semiconductors and Related Devices||26.3%||11.7%||161%|
|KLA-Tencor Corp.||Optical Instruments and Lenses||20.3%||7.8%||111%|
|Intel Corp.||Semiconductors and Related Devices||16.9%||10.2%||116%|
|Applied Materials Inc.||Semiconductors and Related Devices||15.7%||11.7%||117%|
|Qualcomm Inc.||Radio and Televion Broadcasting and Communications Equipment||15.6%||8.8%||-11%|
|Xilinx Inc.||Semiconductors and Related Devices||15.5%||11.2%||122%|
|Nvidia Corp.||Semiconductors and Related Devices||13.5%||11.7%||903%|
|Micron Technology Inc.||Semiconductors and Related Devices||12.5%||11.7%||58%|
|MKS Instruments Inc.||Industrial Instruments for Measurement, Display and Control||12.3%||10.7%||149%|
|Analog Devices Inc.||Semiconductors and Related Devices||12.0%||11.8%||99%|
|Maxim Integrated Products Inc.||Semiconductors and Related Devices||11.2%||11.8%||118%|
|Monolithic Power Systems Inc.||Semiconductors and Related Devices||11.0%||11.8%||279%|
|Lam Research Corp.||Special Industry Machinery, Not Elsewhere Classified||9.5%||12.0%||190%|
|Integrated Device Technology Inc.||Semiconductors and Related Devices||9.0%||11.8%||368%|
|Entegris Inc.||Plastics Products, Not Elsewhere Classified||8.9%||9.4%||149%|
|Teradyne Inc.||Instruments for Measuring & Testing of Electricity and Electrical Signals||8.9%||3.0%||100%|
|On Semiconductor Corp.||Semiconductors and Related Devices||8.1%||11.8%||131%|
|Microchip Technology Inc.||Semiconductors and Related Devices||7.7%||11.8%||83%|
|Silicon Laboratories Inc.||Semiconductors and Related Devices||6.1%||11.8%||103%|
|Qorvo Inc.||Semiconductors and Related Devices||1.9%||11.9%||193%|
|Mellanox Technologies Ltd.||Semiconductors and Related Devices||1.2%||11.8%||135%|
|Cree Inc.||Semiconductors and Related Devices||0.9%||11.8%||-24%|
|Marvell Technology Group Ltd.||Semiconductors and Related Devices||0.9%||11.9%||24%|
|Cypress Semiconductor Corp.||Semiconductors and Related Devices||-6.9%||11.9%||61%|
|Advanced Micro Devices Inc.||Semiconductors and Related Devices||-7.4%||11.9%||432%|
Over the past five years, total returns have not necessarily correlated with high ROCCs for this group of companies. Rapid sales growth has been a primary driver of stock performance. Advanced Micro Devices
lost money four out of the past five full years. But going forward, with analysts (and apparently investors) expecting a dramatic slowdown in growth, shares of the most efficient operators may be the better performers.
You can click on the tickers for more about each company, including news, profiles, stock returns and charts, price ratios and ratings.
For the four components of the PHLX Semiconductor Index for which ROCC is not available, here are average five-year ROIC numbers:
|Company||Ticker||FactSet Industry Group||Avg. ROIC – past five full fiscal years||Total return – five years|
|Taiwan Semiconductor Manufacturing Co. Ltd. ADR||Semiconductors||22.3%||135%|
|ASML Holding N.V. ADR||Electronic Production Equipment||15.5%||82%|
|NXP Semiconductors N.V.||Semiconductors||8.8%||73%|
was formed in 2016 when Avago Technologies of Singapore acquired the “old” Broadcom. The current company was headquartered in Singapore until April, when it relocated to San Jose, Calif. So ROCC numbers are not yet available for Broadcom.
A company’s return on average invested capital is its earnings divided by the sum of total equity and debt.
If you are interesting in individual semiconductor stocks after their recent decline, the ROCC/ROIC numbers may help you to narrow the list of candidates for further research.
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