5 Semiconductor Stocks That Still Have Room to Rally

Fueled by the artificial intelligence boom, many semiconductor stocks have staged a monster rally in 2023, driving valuations higher.

However, not all stocks in the industry have participated in the big gains, leaving some still trading in undervalued territory, according to Morningstar analysts. Others are still undervalued despite posting double-digit gains in 2023.

Among the semiconductor stocks that we still think are priced at a discount:

• Skyworks Solutions SWKS
• Qualcomm QCOM
• Advanced Micro Devices AMD
• Microchip Technology MCHP
• NXP Semiconductors NXPI
  
  

Semiconductor companies design, manufacture, and market microchips and microprocessors. Big names in the space include Nvidia and Texas Instruments TXN. The Morningstar US Semiconductor Index has surged in 2023, gaining 77.8%, while the broader Morningstar US Market Index is up just 14.8%. This marks a significant turnaround from a loss of 37.7% for the Semiconductor Index in 2022, compared to a 19.4% drop in the US Market Index.

AI Fuels Semiconductor Rally

Much of the difference this year stems from the emergence of AI as a driver of profit growth. That’s especially been the case for Nvidia NVDA, which has gained 188% in 2023 and 252% over the last 12 months.

“There is no more important story in semiconductors than the rise in artificial intelligence accelerators, led by Nvidia’s data center graphics processing units,” says Brian Colello, director of technology equity research at Morningstar. “We see the world’s leading cloud computing providers racing to buy enough GPUs to run generative AI for themselves and their customers, and we don’t see this demand slowing anytime soon.”

Colello explains: “If the global economy remains strong, we expect companies to invest in generative AI. If the economy weakens, we expect companies to invest because of the potential efficiencies gained by implementing AI. Similarly, we don’t expect any cloud computing vendor to risk running out of GPU processing capacity for its customers.”

Undervalued Semiconductor Stocks

To find undervalued stocks in this industry, we screened the Semiconductor Index for names that carried a Morningstar Rating of 4 or 5 stars. Out of the 28 stocks in the index, Morningstar analysts cover 15, seven of which are considered fairly valued, including Nvidia. The remaining stocks are all rated 4 stars.

This article also screened for companies with economic moats. Historically, undervalued stocks with moats have performed better over time than less-profitable and more indebted counterparts. They also tend to protect against downturns and be less risky than lower-quality stocks.

The screen left five undervalued semiconductor stocks with moats of May 30, 2023. The most undervalued company on the list is Skyworks Solutions, trading at a 39% discount to its fair value estimate. The least undervalued is NXP Semiconductors, trading at a 19% discount.

Top Undervalued Semiconductor Stocks with Moats

Skyworks Solutions

• Fair Value Estimate: US$155.00

“Skyworks Solutions produces semiconductors for wireless handsets and other devices that are used to enable wireless connectivity. Its main products include power amplifiers, filters, switches, and integrated front-end modules that support wireless transmissions. Skyworks’ customers are mostly large smartphone manufacturers, but the firm also has a growing presence in non-handset applications, such as wireless routers, medical devices, and automobiles.

“We believe Skyworks’ radio frequency products have enabled the world’s adoption of 4G (and increasingly now 5G) mobile devices, the paramount being Apple’s AAPL iPhone series. There have been recent concerns that Apple’s focus on expanding its internal chip capabilities will diminish its reliance on Skyworks. However, we view that assessment as vastly overstated, as Skyworks’ products use different materials and have significantly different design expertise than Apple’s internal semiconductors as of today. We believe Skyworks will achieve high-single-digit long-term revenue growth, as its RF parts will remain essential as an increased number of 5G phones enter the market.”

—Brian Colello

NXP Semiconductors

• Fair Value Estimate: US$240.00

“NXP is a leading supplier of high-performance mixed-signal products. The firm acquired Freescale Semiconductor in 2015 and now has a significant market share in the automotive market, where it supplies microcontrollers and analog chips into automotive clusters, powertrains, infotainment systems, and radars. NXP also serves industrial, Internet of Things, mobile, and communications infrastructure.

“NXP is one of our top picks in the analog and mixed-signal chip space. We’re especially fond of the company’s outsize exposure to the automotive end market, where it obtains nearly 50% of revenue. NXP is well diversified in automotive with a nice product portfolio of processors, microcontrollers, and analog parts. We think it will gain its fair share in electrification and safety automotive products too, such as radar and battery management systems. Overall, NXP’s auto business is well tied to the secular tailwinds of rising chip content per vehicle, and we think the market is too focused on a near-term slowdown in demand. NXP’s mobile business is also stout, with a leadership position in near-field communications solutions.”

—Seth Goldstein, strategist, Brian Colello

Qualcomm

• Fair Value Estimate: US$140.00

“Qualcomm develops and licenses wireless technology and designs chips for smartphones. The company’s key patents revolve around CDMA and OFDMA technologies, which are standards in wireless communications that are the backbone of all 3G, 4G, and 5G networks. Qualcomm’s IP is licensed by virtually all wireless device makers. The firm is also the world’s largest wireless chip vendor, supplying nearly every premier handset maker with leading-edge processors. Qualcomm also sells radio frequency-front end modules into smartphones, as well as chips into automotive and Internet of Things markets.

“We assign Qualcomm a narrow moat, stemming from intangible assets. In our view, the firm’s biggest competitive advantage comes from patents, intellectual property, and decades of R&D expertise in wireless technologies, which the company monetizes via a licensing model. To a lesser extent, Qualcomm’s semiconductor design business also likely earns excess returns on capital and prospers from extensive experience and cumulative R&D in leading-edge baseband chips and applications processors.

—Brian Colello

Advanced Micro Devices

• Fair Value Estimate: US$130.00

“Advanced Micro Devices designs a variety of digital semiconductors for markets such as PCs, gaming consoles, data centers, industrial, and automotive applications, among others. AMD’s traditional strength was in central processing units, CPUs, and graphics processing units, or GPUs, used in PCs and data centers. Additionally, the firm supplies the chips found in prominent game consoles such as the Sony PlayStation and Microsoft Xbox. In 2022, the firm acquired field-programmable gate array leader Xilinx to diversify its business and augment its opportunities in key end markets such as the data center and automotive.

“We assign AMD a narrow economic moat, based on intangible assets around a variety of chip designs (including those from Xilinx, which we gave a narrow moat before AMD acquired it in 2022). We think it is more likely than not that AMD will generate excess returns on capital over the next 10 years, and perhaps even longer.”

—Brian Colello

Microchip Technology

• Fair Value Estimate: US$90.00

“Microchip is a leading supplier of microcontrollers, which are semiconductors that act as the brains in a wide variety of common electronic devices, from garage door openers to electric shavers to dishwashers. We view Microchip as one of the best-run firms within the space, and we like its ability to generate free cash flow under virtually any economic scenario.

“We believe that Microchip has a wide moat stemming from intangible assets around proprietary chip designs and manufacturing expertise, as well as switching costs that make it difficult to swap out chips for competing offerings once they are designed into a given electronic device. Given Microchip’s record of stellar profitability in recent years and its ability to retain its leadership position in MCUs while expanding its analog business, we think it is more likely than not that the company will earn on excess capital over the next 20 years.”

—Brian Colello