Meet the Demand for Semiconductors With These Three Stocks
This week, we use AAII’s A+ Investor Stock Grades to give you insights into three semiconductor stocks benefiting from high demand across numerous industries. For investors focused on companies that supply a key component for vehicles, 5G and the Internet of Things (IoT), consider the three semiconductor stocks of Advanced Micro Devices Inc., Micron Technology Inc. and Texas Instruments Inc.
Demand Exceeds Supply Across the Semiconductor Industry
Semiconductors are used in the manufacturing of various kinds of electronic devices, including diodes, transistors and integrated circuits. These devices have found wide application in most electronic appliances, from refrigerators and rice cookers to laptops and fighter jets. What makes semiconductors attractive is their compactness, power efficiency and low cost. Most importantly, they are integrated into complex circuits. Semiconductors are, and will be in the foreseeable future, the key element for electronic systems, communications, signal processing, computing and control applications in the consumer and industrial markets.
At a recent press conference, Federal Reserve chair Jerome Powell mentioned the supply constraints that are restraining activity across multiple industries, such as the motor vehicle industry, “where the worldwide shortage of semiconductors has sharply curtailed production so far this year.” While the U.S. is the leader in semiconductor design, their manufacturing and production has moved offshore to places such as Taiwan and China. Officials note that this has led to a crisis in the supply chain.
This shortage is the result of large swings in demand due to the pandemic and increased use of semiconductors in advanced vehicles. Finding a market balance will take time, as semiconductors are not produced quickly — 26 weeks is the industry norm. A key factor to restoring balance will be a rebuild of domestic chip manufacturing, as much of the supply chain is held hostage by the Chinese government.
Grading Semiconductor Stocks With AAII’s A+ Stock Grades
When analyzing a company, it is useful to have an objective framework that allows you to compare companies in the same way. This is one reason why AAII created the A+ Stock Grades, which evaluate companies across five factors that have been shown to identify market-beating stocks in the long run: value, growth, momentum, earnings estimate revisions (and surprises) and quality.
Using AAII’s A+ Stock Grades, the following table summarizes the attractiveness of three semiconductor stocks — Advanced Micro Devices, Micron Technology and Texas Instruments — based on their fundamentals.
AAII’s A+ Stock Grade Summary for Three Semiconductor Stocks
What the A+ Stock Grades Reveal
Advanced Micro Devices (AMD) designs and sells digital integrated circuits (ICs), including x86 microprocessors and chipsets for computers, embedded microprocessors for commercial and consumer applications and graphics processors.
It operates through the following segments: computing & graphics, and enterprise, embedded and semi-custom. The computing & graphics segment includes desktop and notebook processors and chipsets, discrete and integrated graphics processing units, data center and professional GPUs and development services. The enterprise, embedded and semi-custom segment includes server and embedded processors, semi-custom system-on-chip products, development services and technology for game consoles.
Graphics processors (GPU) are used in computers to increase the speed of rendering images and to improve image resolution and color definition. Embedded microprocessors are used in applications, such as industrial controls, point of sale/self-service kiosks and casino gaming machines, among others. The accelerated processing unit, or APU, combines a CPU and GPU onto a single piece of silicon. This architecture can provide a substantial improvement in user experience, performance and energy efficiency.
The microprocessor market is a critical part of the semiconductor industry, and is dominated by two companies, Intel and AMD. The two competitors have battled for preeminence in the segment for decades. AMD accounts for less than 20% of the microprocessor market and has made many changes over the years to build a sustainable business model.
Advanced Micro Devices has a Value Grade of F, based on its score of 87, which is considered ultra-expensive. The company’s Value Score ranking is high across several traditional valuation metrics, with a score of 81 for the price-to-free-cash-flow ratio, 93 for the price-to-book-value ratio and 88 for the enterprise-value-to-EBITDA ratio (remember, the lower the score the better for value). Successful stock investing involves buying low and selling high, so stock valuation is an important consideration for stock selection.
The Value Grade is the percentile rank of the average of the percentile ranks of the valuation metrics mentioned above along with price-earnings ratio, price-to-sales ratio and shareholder yield.
Advanced Micro Devices has a Momentum Grade of B, based on its Momentum Score of 72. This means it ranks in the top tier of all stocks in terms of its weighted relative strength over the last four quarters. The weighted four-quarter relative strength rank is the relative price change for each of the past four quarters.
Micron Technology (MU) is a manufacturer of semiconductor memory products, including dynamic random-access memory (DRAM) and NAND flash memory, as well as image sensors. DRAM products are semiconductor devices with low latency that provide high-speed data retrieval with various performance characteristics. NAND products are non-volatile, rewriteable semiconductor storage devices that provide high-capacity, low-cost storage with various performance characteristics. The company’s products are used in an increasingly broad range of electronic devices, including personal computers, network servers, mobile phones, digital still cameras and other consumer electronics products.
It operates through the following segments: compute and networking business unit (CNBU); mobile business unit (MBU); storage business unit (SBU); and embedded business unit (EBU). The CNBU segment includes memory products sold into cloud server, enterprise, client, graphics and networking markets. The MBU segment offers memory products sold into smartphones and other mobile-device markets. The SBU segment comprises solid-state drives (SSDs) and component-level solutions sold into enterprise, cloud, client and consumer SSD markets other discrete storage products sold in component and wafer forms to the removable storage markets. The EBU segment consists of memory and storage products sold into automotive, industrial and consumer markets.
Earnings estimate revisions offer an indication of what analysts are thinking about the short-term prospects of a firm. Micron Technology has an Earnings Estimate Revisions Grade of B, which is considered positive. The grade is based on the statistical significance of its last two quarterly earnings surprises and the percentage change in its consensus estimate for the current fiscal year over the past month and past three months.
Micron Technology has posted a positive earnings surprise for the last two fiscal years. Over the last month, the consensus earnings estimate for the fiscal year ending August 31, 2021, has increased nearly 8% from $4.09 per share to $5.936 per share; all revisions have been positive.
Micron Technology has a Momentum Grade of C, based on its Momentum Score of 54, and a strong Growth Grade of B. Micron Technology does not currently pay a dividend.
Texas Instruments (TXN) is a semiconductor design and manufacturing company. With design, manufacturing or sales operations in more than 30 countries, Texas Instruments is a global supplier of chips to electronics designers and manufacturers. The company has a focus on analog and embedded processing products.
It operates in two primary segments: analog (76% of 2021 first-quarter sales; 85% of operating profit) and embedded processing (18% of sales; 15% of operating profit). The company’s “other” segment (6% of sales; less than 1% of operating profit) includes DLP projectors, calculators, custom ASIC and royalties.
Texas Instruments is the world’s largest maker of analog chips. Analog semiconductors are used to condition, amplify or convert signals such as sound, temperature, pressure or images to data that can be processed by other semiconductors. Analog semiconductors are also used to manage power in every electronic device. Embedded processing products are the digital brains of many types of electronic equipment. They are designed to handle specific tasks and can be optimized for various combinations of performance, power and cost, depending on the application.
An important factor in analog’s attractiveness is its relatively steady and profitable business model. Analog companies tend to have thousands of products and a very broad customer base, which lend stability to the revenue stream. Analog markets are also appealing because these are not commodity products. When a company wins a spot in a customer’s product, however, the price is apt to be fixed for the run of the product — often a year or so — which makes for greater price stability than in many digital markets, where commodity pricing pressures prevail.
Texas Instruments has an average A+ Growth Grade of C. The growth grade considers both the near- and longer-term historical growth in revenue, earnings per share and operating cash flow.
The company has exhibited strong sales growth over the past year. Sales increased 41.4% year over year for the three-month period ending June 30, 2021, to $4.6 billion, while operating cash grew over 23.3%. Texas Instruments currently has a 2.1% dividend yield.
A higher-quality stock possesses traits associated with upside potential and reduced downside risk. Backtesting of the quality grade shows that stocks with higher quality grades, on average, outperformed stocks with lower grades over the period from 1998 through 2019.
Texas Instruments has a Quality Grade of A, putting it in the top tier among all U.S.-listed stocks.
The A+ Quality Grade is the percentile rank of the average of the percentile ranks of return on assets (ROA), return on invested capital (ROIC), gross profit to assets, buyback yield, change in total liabilities to assets, accruals, Z double prime bankruptcy risk (Z) score and F-Score. The score is variable, meaning it can consider all eight measures or, should any of the eight measures not be valid, the valid remaining measures. To be assigned a quality score, though, stocks must have a valid (non-null) measure and corresponding ranking for at least four of the eight quality measures.
The company ranks highly in terms of its return on assets and F-Score, ranking respectively in the 98th and 95th percentile of all U.S.-listed stocks. However, it ranks poorly in terms of its change in buyback yield, in the 51st percentile.
The company has a Momentum Grade of C, based on its Momentum Score of 53.
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The stocks meeting the criteria of the approach do not represent a “recommended” or “buy” list. It is important to perform due diligence.
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