The last 15 months have been a pretty wild ride for chip stocks, with a late-2018 tumble followed by a much better 2019 that (in spite of a roughly 20% spring selloff) has left the Philadelphia Semiconductor Index up 46% on the year as of Monday's close.
The sector has comfortably outperformed the Nasdaq (up 29%), with a wide variety of chip industry firms sporting 50%-plus gains. This list includes chip equipment vendors such as Applied Materials (AMAT) and ASML (ASML) , EDA software vendors such as Cadence Design Systems (CDNS) and Synopsys (SNPS) , microcontroller (MCU) and analog chip suppliers such as NXP Semiconductors (NXPI) and STMicroelectronics (STM) , and fabless chip developers such as AMD (AMD) , Marvell Technology (MRVL) and Cirrus Logic (CRUS) .
Following such big run-ups, should would-be chip stock investors stay on the sidelines and wait for better entry points? The answer is probably "yes" in many cases. But at the same time, it's not fair to say that there's no value left to be found at this point.
Certainly -- speaking as someone who was generally positive on chip stocks at lower levels -- a lot of the easy money has been made here. In late 2018, the sector was pricing in (amid concerns about trade tensions, Fed policy and near-term sales trends) a massive cyclical downturn that never materialized, even if many chip developers and equipment makers have seen revenue declines this year. Chip stocks aren't that cheap anymore, and unless a recession arrives, they might not be that cheap again for a while.
But given that valuations were often quite low to begin with, multiples for some quality names still don't look that awful. Just to give a few examples, NXP trades for 13.7 times its expected 2020 EPS, Qorvo (QRVO) trades for 15.6 times its expected fiscal 2021 (ends in March 2021) EPS, ON Semiconductor (ON) trades for 13.4 times its expected 2020 EPS and (though it's worth noting that it's very hard to predict what a memory maker will earn more than a quarter or two out) Micron (MU) trades for 9.1 times its expected fiscal 2021 (ends in August 2021) EPS.
One common thread for these companies: They're all chip developers that own their own manufacturing plants (fabs). Collectively, these companies have long traded at a discount to their fabless peers, apparently due to worries about how their fixed manufacturing costs would impact earnings during a major cyclical downturn. But now as before, this discount arguably looks excessive, particularly given that many of these firms have strong exposure to growth opportunities in end-markets such as cars, data centers and 5G phones.
When it comes to fabless chip developers, one might need to go off the beaten path a bit to find bargains at this point. Korean flash memory/SSD controller supplier Silicon Motion (SIMO) , which is benefiting from rising SSD penetration rates, is one name that still doesn't look too expensive. Mellanox Technologies (MLNX) , which trades about $10 below Nvidia's $125-per-share buyout price amid Chinese approval concerns, might also present an interesting risk/reward. With Mellanox trading for 16.2 times its 2020 EPS consensus (less than many fabless peers) and maintaining a leadership position in a growing market for high-speed data center interconnects, its downside might be limited even if the Nvidia deal doesn't go through.
A lot of chip equipment makers still don't carry high valuations on an absolute basis -- Applied, for example, trades for 15.3 times its expected fiscal 2020 (ends in Oct. 2020) EPS. But the group still faces some near-term headwinds related to weak memory capital spending, and is already seeing a top-line boost from Intel and Taiwan Semiconductor's recent capex budget hikes. As a result, it might be better for those not currently invested in the space to hold off for now.
And more broadly speaking, considering how much the pendulum has swung for chip stocks over the last 12 months from excessive pessimism to a high level of optimism, there's a case to be made for holding off on buying chip stocks in general, out of the expectation that the pendulum will eventually swing back a bit and yield more attractive valuations for names that kind of look compelling right now.
However, that's something quite different than viewing the chip sector to be massively overvalued on the whole following this year's giant gains. The story is a lot more complicated than that.