Semiconductor Outlook: Further Upside In The Cards

Being on the building-block side of technology, the industry will continue to benefit from the proliferation of the Internet and the growing digitization of our lives in the foreseeable future.

Moreover, because of the growth potential in emerging markets, regulatory (and/or political) issues, particularly in places like China, can play an increasingly important role. At the same time, because end devices in these markets have to be priced lower, the pressure on companies to bring down cost will remain.

So companies will find it advantageous to move operations to places where labor may be cheaper or the proximity to manufacturing facilities can lower transportation and other cost.

Another feature we are likely to see more often is close collaboration with device makers facilitating quicker consumption and better inventory management.

Industry Offers Solid Shareholder Returns

The Zacks Semiconductor-General Industry, which is a 7-stock group within the broader Zacks Computer And Technology Sector, has outperformed both the S&P 500 and its own sector over the past year.

So we see that the stocks in this industry have collectively gained 53.2% over the past year, while the Zacks S&P 500 Composite and Zacks Computer and Technology Sector have rallied 13.9% and 16.1%, respectively.

While the industry is small, players like Intel (NASDAQ:INTC) , NVIDIA, Texas Instruments and STMicroelectronics (NYSE:STM) are very important sector players, contributing to the performance of both the sector and the S&P 500.

One-Year Price Performance

Semi-General Stocks Look Expensive

The strong run in share prices over the past year have, however, led to a relatively rich valuation.

Comparing the industry to the S&P 500 on the basis of price to forward 12 months’ earnings, we see that the industry’s 19X in ahead of the S&P 500’s 17.1X.

It does however compare favorably with the sector’s 19.3X.

Comparing the industry to the S&P 500 on the basis of price to forward earnings growth, we see that the industry’s 2.3X is again ahead of the S&P 500’s 1.8X.

It is also ahead of the sector’s 1.7X.

Comparing the industry to the S&P 500 on the basis of price to free cash flow, we see that the industry’s 30.7X is again ahead of the S&P 500’s 22.6X.

It is also ahead of the sector’s 19.8X.

So any way you cut it, the industry is overvalued.

Outperformance May Continue Due to Solid Growth Potential

With no end in sight to top line expansion from cloud computing, big data, IoT, auto and other mass market adoption, the main concern for stocks in this industry is the bottom line. This could be impacted among other things by growing competition between players and the constant need to innovate. But because of the high level of differentiation inherent in the business, profit margins may be expected to remain attractive.

The above ratio analysis shows that investors are upbeat about the solid prospects but the real question for them is whether this group has the potential to continue performing better than the broader market in the quarters ahead.

One way to find out is by taking a look at the earnings outlook for the constituent companies since empirical research shows that a company’s earnings outlook significantly influences its stock’s performance. In this respect, a comparison of the consensus earnings expectation for the current financial year with last year’s reported number could be indicative of its prospects.

The charts below show the magnitude and direction of change in earnings estimates. The consensus earnings estimate for the Zacks Semi-General industry of $3.96 per share implies a strong double-digit year-over-year improvement, with the trend in earnings estimate revisions remaining positive throughout.

Price and Consensus: Semi-General Industry

Looking at the aggregate earnings estimate revisions, it appears that analysts remain confident about this group’s earnings potential.

The consensus EPS estimate for the current fiscal year is up 8.8% since Mar 31, 2018.

Current Fiscal Year EPS Estimate Revisions

Zacks Industry Rank Indicates Bright Prospects

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates continued outperformance in the near term.

The Zacks Semi-General industry currently carries a Zacks Industry Rank #11, which places it at the top 4% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

Our proprietary Heat Map shows that the improvement in the industry’s rank has been more or less consistent over the past five weeks.

Semi-General Stocks Promise Long-Term Growth

While the near-term prospects look attractive for investors, the long-term (3-5 years) EPS growth estimate for the Zacks Semi-General industry appears unclear. This could be because it is hard to project what exactly will happen 3-5 years out at the cutting edge of technology. The group’s mean estimate of long-term EPS growth rate of 8.3% is therefore unchanged since the beginning of the year. This compares to 9.7% for the Zacks S&P 500 composite.

Mean Estimate of Long-Term EPS Growth Rate

The long-term growth is a continuation of strong performance over the past few years. Take revenue for example, which has gained momentum since 2016.

Or the EBIT margin, which shows an attractive upward trend.

Investments are clearly continuing with the book value per share rising steadily.

At the same time, the tangible book value is trending down, as most of the value is locked in patents, with manufacturing and other facilities being managed efficiently.

Bottom Line

This is a great place to invest in right now, both with respect to the near term and the longer term. While valuations do appear rich, there are indications that the momentum will continue. So while the more cautious of us might wait for a better entry point, here are some stock picks for the rest-

NVIDIA Corp (NASDAQ:NVDA) : The stock has gained 64.8% over the past year. The Zacks Consensus Estimate for the current-year EPS is up 12.5% in the last 60 days.

Price and Consensus: NVDA

Texas Instruments (NASDAQ:TXN) : The stock has gained 37.5% over the past year. The Zacks Consensus Estimate for the current-year EPS is up 10.3% in the last 60 days.

Price and Consensus: TXN

Xcerra Corp (NASDAQ:XCRA) : The stock has gained 41.0% over the past year. The Zacks Consensus Estimate for the current-year EPS is up 4.0% in the last 60 days.

Price and Consensus: XCRA

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