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Valuations for chip stocks are approaching levels in 2021 when the Nasdaq 100 Stock Index ($IUXX) (QQQ) soared to a record high. Likewise, after climbing +28% so far this year, the Philadelphia Semiconductor Index ($SOX) is trading at a price-to-projected earnings ratio that’s approaching peak levels from two years ago, when the pandemic fueled a surge in demand for everything from personal computers to televisions that chipmakers couldn’t keep up with.
Chip stocks tumbled last year as weak demand boosted chip inventories. However, chip stocks are climbing this year, hoping for a recovery as signs emerge that companies are working through excess inventory and seeing improved demand. However, with the global economy expected to slow due to the aggressive rate-hike campaign from the world’s central banks, chip demand may not increase enough to clear excess chip inventories. Wedbush Securities said they struggle to explain why the stocks have rallied so much, saying,” The semiconductor recovery is getting shallower and later.”
Semiconductor demand is a leading indicator of demand for electronics. Makers of electronic devices are accustomed to long lead times, the interval between ordering and taking delivery of chips, of as long as a year from their chip suppliers. Those long lead times often lead to boom-to-bust cycles, as customers can quickly cut orders when demand falters.
The recent optimism and rally in chip stocks have pushed the valuation of the Philadelphia Semiconductor Index from 13 times projected profits in October to 21 today, just below its peak of 24 times in 2021, according to data compiled by Bloomberg. Nvidia (NVDA) trades at 56 times projected profits after the stock surged more than +80% this year, fueled by speculation its sales will be supercharged by investments in gear to power artificial intelligence applications.
Recent demand data for chips has not been encouraging. The World Semiconductor Trade Statistics Organization reported that total chip sales fell -4% in February, the sixth consecutive year-over-year sales decline. Also, earnings estimates for chip makers continue to deteriorate. As a result, earnings for chip-related companies in the S&P 500 are projected to drop about 25% in 2023, down from expectations for a 16% contraction at the beginning of the year. Jeffries said the combination of rising stock prices and falling profits could make for a difficult earnings reporting season for chipmakers as “the set-up into earnings season is more challenging than it has been for the past six quarters given significant outperformance over the past five months.”
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On the date of publication, Rich Asplund did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
