Published on June 22nd, 2018 by Josh Arnold
Semiconductor stocks tend to see periods of high growth when economic conditions are strong and thus, their stocks can offer high potential total returns.
In addition, strong profitability from the group affords these companies the ability to return large amounts of capital to shareholders, making the semiconductor group an interesting one for dividend investors. Valuations in the sector have also diverged of late, making some stocks more attractive than others.
In this article, we’ll take a look at the seven semiconductor stocks we have in our coverage universe and rank them according to their total return potential. The stocks we’ll rank include Qualcomm (QCOM), NVIDIA (NVDA), Intel (INTC), Texas Instruments (TXN), Broadcom (AVGO), KLA-Tencor (KLAC) and Applied Materials (AMAT).
More information can be found in the Sure Analysis Research Database, which ranks stocks based upon the combination of their dividend yield, earnings-per-share growth potential and valuation to compute total returns. The stocks are listed in order below, with #1 being the most attractive for investors today.
All the stocks in this article pay dividends to shareholders, which means they can be found on our complete list of 331 dividend-paying technology stocks.
Read on to see which semiconductor stock is ranked the highest in our Sure Analysis Research Database.
Semiconductor Stock # 7 – Qualcomm, Inc. (QCOM)
Qualcomm (QCOM) was founded in 1985 as a provider of communications services for long-haul truck drivers. The company now sells integrated circuits for use in data and voice communications, producing almost $80B in annual revenue. Today, its market cap has grown to $88B.
Qualcomm’s recent Q2 earnings report showed adjusted earnings-per-share of 80 cents, which beat estimates by 10 cents. Revenue declined 13.2% YoY due to the lack of royalty payments made by Apple’s manufacturers in a longstanding dispute over such fees. Qualcomm has made concessions in its feud with Apple but the impact to revenue has been substantial nonetheless. Qualcomm is also ready to close on its $44B acquisition of NXP Semiconductors (NXPI).
Source: Q2 earnings presentation, page 7
Qualcomm enjoys significant exposure to the mobile device market and as shown in this slide, shipments of such devices globally continue to grow. As more of the world’s population enters the middle class, device shipments should continue to outpace growth in the population, meaning Qualcomm has a long term tailwind to growth as the market for its products increases in size.
Qualcomm has averaged 6.6% earnings-per-share growth in the past decade as royalty payments from the mobile device boom have accelerated. The dispute with Apple continues to take its toll, however. Qualcomm’s pending acquisition of NXP would help the company diversify away from mobile devices and into the personal security and automotive markets, but the deal is not yet complete. Given these factors, we see earnings-per-share growth at a below average 4% annual rate moving forward.
Qualcomm’s dividend has been increased for each of the past 16 years, most recently adding 9% to the payout. Qualcomm is a Dividend Achiever, a group of stocks with at least 10+ consecutive years of dividend growth. You can see the full list of all 266 Dividend Achievers here.
We see the current 4.2% growing slightly to 4.4% in the coming years as Qualcomm continues to raise its dividend.
Qualcomm’s price-to-earnings ratio has averaged 15.8 over the past decade. However, given the uncertainty around the company’s disagreement with Apple as well as the pending acquisition of NXP, we think fair value is more like 14 times earnings. At today’s price-to-earnings ratio of 16.7, we see a 3.5% headwind to total returns from a normalizing valuation.
Qualcomm shareholders can therefore expect total annual returns of 4.7% over the next five years, consisting of the current 4.2% yield, 4.0% earnings-per-share growth and a 3.5% headwind from a lower valuation, making Qualcomm the weakest stock in this group for projected total returns.
Semiconductor Stock # 6 – NVIDIA (NVDA)
NVIDIA (NVDA) is a specialized semiconductor manufacturer that competes in graphics processors, chipsets and related software. The company was founded in 1993, produces $13B in annual revenue and has a market cap of $161B.
The company’s recent Q1 earnings report showed record performances from revenue and earnings-per-share, rising 66% and 151%, respectively. Growth was driven by record datacenter revenue, which rose 71% YoY, as NVDA continues to capitalize on a variety of favorable trends within its markets.
NVDA produced record revenue, gross margin, operating income and earnings-per-share last year as a result of its significant growth drivers; this company is fully capitalizing on its exposure to several key markets like autonomous cars, cloud computing and gaming and the results have been extraordinary. Indeed, Q1 results would suggest more growth like this is coming.
We are forecasting robust 15% earnings-per-share growth annually for NVDA moving forward as it continues to take advantage of growth in gaming, cryptocurrency mining as well as artificial intelligence applications, including facial recognition. The addressable markets for NVDA continue to expand and as it takes share in those markets, revenue and earnings growth should be very strong.
NVDA’s yield is just 0.2% and we don’t see that changing anytime soon as the company continues to focus on growth, not returning capital to shareholders via dividends.
NVDA’s price-to-earnings ratio has increased drastically in recent years and today, stands at 39.3. That is well in excess of fair value, which we see as 25 times earnings, implying a sizable 8.6% headwind to total returns annually as the valuation normalizes.
NVDA shareholders can therefore expect total annual returns of 6.6% moving forward, consisting of the current 0.2% yield, 15% earnings-per-share growth and a headwind of 8.6% from a lower valuation over time. NVDA’s staggering growth potential appears to be fully priced into the stock at present.
Semiconductor Stock # 5 – Intel Corporation (INTC)
Intel is the largest manufacturer of microprocessors for personal computers in the world, owning roughly 85% of the total market. It also produces servers and storage devices for cloud computing, affording it $68B in annual revenue and a $248B market cap.
The company’s Q1 earnings report showed 87 cents in earnings-per-share, a 32% increase YoY and beating estimates by 15 cents. The company’s revenue also grew 9%, beating expectations by more than a billion dollars. Growth continues to be led by the company’s data-centric businesses, growing 25% during Q1.
Source: Q1 Earnings Presentation, page 6
This slide shows that an important piece of Intel’s earnings outlook is its continued focus on lowering costs, which it is doing very well. Q1 saw operating margins rise by 3%, an impressive feat accomplished by disciplined R&D as well as SG&A spending, something we expect will continue. As Intel continues to grow its revenue, lower costs will afford it greater operating leverage and thus, earnings-per-share growth should outpace that of revenue.
Earnings-per-share growth has averaged a robust 14% annually for the past decade for Intel, but since 2010, that number has fallen to 7% per year. We are therefore forecasting that same rate of growth moving forward for Intel. This growth will be achieved by continued expansion of its data-centric revenue base, which now comprises about half of the company’s total top line.
The company’s strong profitability allows it to return a lot of cash to shareholders as well, as the most recent dividend raise was 10%. We see the yield remaining roughly where it is today around 2.3% as the dividend continues to grow to meet a rising stock price.
Intel has traded with an average price-to-earnings ratio in the past decade of just under 12, but given the improved growth outlook, we see fair value as 13 times earnings. Today’s ratio of 13.8 is therefore slightly in excess of fair value, and as a result, we are forecasting a modest 1.2% headwind to total returns from a normalizing valuation.
Intel has seen a huge run in its share price since the start of 2017 and thus, we forecast 8.1% total annual returns moving forward. These will consist of the current 2.3% yield, 7.0% earnings-per-share growth and a 1.2% headwind from a slightly lower valuation. Intel offers investors a fair price for solid levels of growth and a decent yield.
Semiconductor Stock # 4 – Texas Instruments (TXN)
Texas Instruments is a semiconductor company that operates in Analog and Embedded processing. Its products are used to measure temperature, sound and other physical data. It was founded in 1930 and produces $16B in annual revenue, giving it a current market cap of $112B.
TXN’s recent Q1 earnings report showed an 11% increase in revenue YoY, driven by industrial and automotive customer demand. Operating profit grew 24% over the prior year quarter and earnings-per-share was up 39%, helped in part by a lower tax rate.
In addition to strong earnings growth, TXN continues to produce and return enormous amounts of cash to shareholders. Indeed, it has returned more than $5B in the past twelve months to shareholders via dividends and buybacks, and the reason it has been able to do that is because of robust free cash flow margins. FCF/share has grown at an average rate of 13%, as seen above, making TXN a cash-rich company that is more than willing to share that cash with investors.
TXN has averaged 12% annual earnings-per-share growth in the past decade, a period which includes the Great Recession. We see similar growth going forward of 11.5% annually as TXN continues to take advantage of rising demand in industrial and automotive applications. In addition, it will continue to buy back stock, as it has repurchased more than 40% of its float going back to 2004, a very impressive feat indeed. TXN’s margins should continue to rise as well, as additional volume leads to operating leverage, as we saw in Q1.
We see the dividend growing meaningfully over time and as a result, the yield should move up from today’s 2.2% to 2.5% over time. TXN has proven it is willing and able to return large amounts of cash to shareholders and that shouldn’t change in the coming years, with the dividend being the main beneficiary.
TXN’s current price-to-earnings ratio of 23.6 is well in excess of fair value, which we see as 19 times earnings. We are therefore forecasting a moderate 4.2% headwind to total returns going forward as the valuation reverts back to more normalized historical levels.
We see total annual returns for TXN at 9.5%, consisting of the current 2.2% yield, 11.5% earnings-per-share growth and a 4.2% headwind from the valuation that is currently in excess of fair value. TXN would represent strong growth potential, but that potential is somewhat priced into the stock at present.
Semiconductor Stock # 3 – Broadcom (AVGO)
Broadcom designs, develops and sells semiconductors for a diverse base of customers in infrastructure, wireless communication, enterprise storage and more. Broadcom has recently relocated to the US and is now headquartered in San Jose, CA. The company was founded in 1961 and is currently valued at $113 billion, producing $21B in annual revenue.
The company’s recently reported Q2 earnings showed considerable strength as revenue was up 20% YoY and operating profits more than doubled. Strength came from slightly higher gross margins as well as significant operating leverage from lower expenses. Adjusted earnings-per-share came in 32% higher than the comparable quarter last year. In addition, the company spent $347M on share repurchases during the quarter, as well as another $1.2B in the first four weeks of the third quarter.
Broadcom is a bit different from some of the others in this group as it has a very diverse group of customers in a variety of industries. The core wired infrastructure business makes up less than half of revenue, meaning Broadcom is less susceptible to downturns in any particular business or from a subset of customers.
Broadcom has done a tremendous amount of M&A over the past decade or more, resulting in some pretty spectacular earnings growth. However, given its current size and the scrutiny large tech mergers are receiving, it seems unlikely Broadcom would be allowed to continue to buy growth on the scale it has in the past. Thus, we are forecasting 10.3% earnings-per-share growth going forward, which is well off of Broadcom’s historical average, but still very robust indeed. This growth will come from slight share growth from Broadcom within its markets but mostly, it will be due to expansion in the markets the company serves as well as share repurchases.
Broadcom’s price-to-earnings multiple hasn’t moved up as much as other companies in the sector and today, it sits at just 13.2. That compares favorably to our fair value estimate of 13.5 times earnings, implying a 0.5% tailwind to total annual returns moving forward. On the whole, Broadcom looks fairly valued here, which is much better than the majority of its competitors.
Broadcom is also a tremendous dividend growth story as it has managed to average a 51% annual increase to its dividend for the past five years. That sort of increase isn’t reasonable to expect moving forward, but we see the dividend nearly doubling in five years to $13 per share.
Overall, Broadcom looks like it still has some strong growth ahead of it and is fairly valued, leading to total annual returns of 13.4%. The stock will achieve this via 10.3% earnings-per-share growth, a 0.5% tailwind from a higher price-to-earnings multiple and the current 2.6% yield. Broadcom would therefore be appropriate for those seeking growth at a reasonable price, a nice current yield or those seeking dividend growth.
Semiconductor Stock # 2 – KLA-Tencor Corporation (KLAC)
KLA-Tencor is a semiconductor supplier, offering process control and yield management systems for producers such as Samsung and Micron. The company was founded in 1997 through a merger between KLA Instruments and Tencor Instruments and today, has $4B in annual revenue and a $17B market cap.
KLAC’s recently reported Q3 earnings were terrific as the company posted a 25% increase YoY in earnings-per-share. Its revenue was up 12% as well, but it saw some operating leverage from lower costs as a percentage of revenue. KLAC’s Q3 results were near the top end of guidance provided during the Q2 earnings release, as its strong performance continued.
Guidance for Q4 was solid as well as earnings-per-share is forecast to grow from Q3’s level of $2.02 to a midpoint of $2.12. KLAC sees gross margins declining slightly but higher volumes and lower operating costs should drive net income growth similar to what we’ve seen so far this year; this growth story is very much alive and well.
KLAC’s earnings-per-share growth has been lumpy to say the least over the past decade but overall, it has seen 9% average expansion per year. This year it stands to gain from a lower tax rate and looking forward, we see 8.6% annual earnings-per-share growth. KLAC will achieve this result via share repurchases as well as continued margin growth and revenue expansion.
KLAC is present in growth industries for semiconductors, meaning its rate of revenue should naturally rise over time whether it takes share from competitors or not. KLAC also continues to buy growth, as evidenced by its early 2018 acquisition announcement of Orbotech (ORBK). It has further proven that the margin expansion story is far from over and thus, we think high single digit earnings-per-share growth is reasonable over the long term. Given all of these factors, KLAC’s growth outlook is very bright.
The dividend has seen significant but irregular growth over the past decade and today, the stock yields 2.7%. We think the dividend will rise from today’s level of $2.84 to nearly $5 in five years, meaning the yield should remain in the mid-2% range, keeping pace with the rising stock price.
KLAC’s price-to-earnings ratio has averaged 16 over the past decade but today, the stock is trading for 14.1 times earnings. That makes KLAC favorably valued here in a sector with a lot of overvalued stocks and should provide a 2.3% tailwind to total annual returns moving forward, as the valuation normalizes over time. Given KLAC’s growth outlook, there is no reason it shouldn’t trade at least at its historical norm in terms of its price-to-earnings ratio.
Overall, we expect KLAC will return an impressive 13.6% annually to shareholders over the next five years. These returns will come from the current 2.7% yield, 8.6% earnings-per-share growth and a 2.3% tailwind from the rising valuation. KLAC’s impressive dividend growth therefore makes it appropriate for just about any type of investor as it offers growth, value, a nice current yield and dividend growth prospects.
Semiconductor Stock # 1 – Applied Materials (AMAT)
The best semiconductor stock in our coverage universe is Applied Materials, a company that was founded in a small office unit in 1967. Since that time, it has undergone some transformative changes that have afforded it some fairly spectacular rates of growth and today, it has a market cap of $49B and does almost $18B in annual revenue.
AMAT’s recently reported Q2 earnings were strong but the company saw an adverse investor reaction due to guidance. During Q2 revenue was up 29% YoY and operating margins expanded 240bps, providing a further boost to profitability. AMAT reduced the float by 4% during Q2 as well, although at-consensus guidance for Q3 is what stole the show with investors.
This slide shows us the long term growth drivers for AMAT as it continues to produce some pretty stellar results. Growth comes from not only double digit annual revenue growth, but higher margins. AMAT’s continuously higher volumes allow it to find efficiencies in its processes that drive down operating costs, providing a virtuous cycle of improving profitability, something we think will continue for the foreseeable future.
AMAT remained profitable during the Great Recession but the decline in earnings was substantial. A quick recovery in earnings led to another, multi-year decline in earnings-per-share but since the bottom in 2013, AMAT’s results have been nothing short of spectacular. We are projecting 9.4% annual earnings-per-share growth as a result of a continuation of this trend, and AMAT has several levers it can pull to achieve this result.
Revenue continues to move substantially higher as volumes from television and mobile device manufacturers remains robust. Given the upward trajectory in both of those markets, AMAT stands to gain enormously in the coming years. In addition, AMAT has proven adept at growing margins over time as volume increases, meaning we should see ever-higher rates of profitability. Finally, management has committed to buying back a lot of stock, having $6B on its current authorization, good for more than 12% of the float at today’s prices, and providing further upside potential to earnings-per-share as the float is reduced meaningfully over time.
The dividend is not a priority for management as they choose instead to buy back stock, but we see the payout growing by roughly half in the coming years to $1.20 per share. That won’t be enough to make AMAT an income stock, as its yield should still be somewhere around 1% at that time, but given the growth we see coming, the dividend shouldn’t be the draw for investors at this point.
AMAT’s valuation was once very high but today, its price-to-earnings ratio is just 11. That compares very favorably to the company’s historical norm of 16.8 and as a result, we think AMAT will see an 8.8% tailwind to total annual returns as a result of the rising valuation. AMAT shares have become exceedingly cheap and that is a big reason why it is the best semiconductor stock in our coverage universe right now.
Overall, AMAT looks very attractive here, offering investors 19.9% total annual returns moving forward. This high level of performance will come from 9.4% earnings-per-share growth, the current 1.7% yield and an 8.8% tailwind from a higher price-to-earnings ratio. AMAT is far and away the most attractive semiconductor stock in our Sure Analysis Research Database at present.