[Editor’s note: This story was previously published in August 2018. It has since been updated and republished. While the author’s position may have changed, we believe the stock picks still provide value.]
Chip stocks have been among the market’s biggest winners over the past several years. Huge demand tailwinds from the data center, cloud computing, connected device and artificial intelligence (AI) markets have converged on a limited-supply base, creating a “high demand, low supply” dynamic in the chip market wherein chip prices are soaring. Consequently, chipmakers have seen revenues and profits dramatically improve over the past several years. Such improvements have driven huge gains in chip stocks.
Going forward, the outlook is less certain. Chip supply won’t remain subdued forever — it is already ramping to meet demand, and there are some reports out there that chip prices may have already peaked.
Thus, when looking out over the next several years, increased chip supply means that it will be difficult for chip stocks to remain red-hot.
But, some chip stocks will still do very well due to solid fundamentals. With that in mind, here’s a list of three chip stocks which I think will keep performing for investors over the next three years.
For the first eight months of 2017, Intel (NASDAQ:INTC) stock was stuck in neutral. The PC business was largely tapped out. Growth wasn’t really coming from anywhere. Margins were under pressure. INTC stock bounced around in the mid-$30s.
Then, Intel embraced a huge shift from a PC-centric business to a data-centric business. That broadened the company’s exposure from exclusively PCs to today’s high-growth data-center and AI markets. Intel’s data-centric business started to take off, and INTC stock soared to nearly $60.
Now, the market is getting bearish on INTC stock again. The consensus belief is that this company’s days of gaining market share in high-end cloud computing markets are over, and that competition will erode growth for the foreseeable future. INTC stock has traded down on this consensus belief to a current level around $50.
But, while this may be true for the next few months, Intel losing share is not a permanent thing. Historically speaking, Intel always fights back, defends market share and remains a prominent player. Plus, Intel has the scale and resources to overpower a lot of its competitors.
From this perspective, the recent selloff in INTC stock seems overdone. This is a company with healthy revenue and earnings growth potential over the next several years through continued growth in its data-centric business.
I reasonably see $5.50 in earnings per share in five years. A historically average 13X forward multiple on that implies a four-year forward price target of $71.50. Discounted back by 10%, that equates to three-year forward price target of $65, which represents 30% upside from current levels.
Shares of Micron (NASDAQ:MU) roared from $10 to $60 in two years because the supply-demand fundamentals in the memory chip market were increasingly favorable for suppliers like Micron. As stated in the intro, though, those supply-demand fundamentals are becoming increasingly less favorable. Consequently, MU stock has dropped to $50 $35 over the past several months.
When it comes to MU stock, though, the aforementioned supply ramp concerns are significantly overstated and lack an understanding of the company’s demand tailwinds.
While demand in the memory chip market is forecast to slow, demand from datacenter, IoT, autonomous driving and AI markets will remain big growth markets for the next three to 10 years. Thus, regardless of where supply goes, demand will remain robust. Robust demand against rising supply means that chip prices will remain relatively high, and that Micron’s earnings will remain strong.
Normally, these supply ramps last two years, and cause earnings per share at Micron to drop $4 during that stretch. Earnings this year (fiscal 2018) are expected to peak around $12 per share. Thus, history says that earnings will shake out around $8 per share by fiscal 2020.
Over the past five years, MU stock has historically traded around 9x forward earnings. Applying that historically average 9X forward multiple to $8 in earnings per share in fiscal 2020 implies a fiscal 2019-end price target of $72. That represents 40% upside from current levels.
When it comes to chip stocks, the reason to own them for the long haul is to gain broad exposure to multiple data-centric markets that are currently nascent but oozing with hyper-growth potential. These markets include data-centers, IoT, AI, automation, and AR/VR.
When it comes to those markets, no chip stock is as dominant as Nvidia (NASDAQ:NVDA). That is why NVDA stock has gained more than 1,000% over the past three years. Because these markets are still in their early stages, NVDA stock also has a lot of growth left over the next several years.
Just look at the markets Nvidia is servicing. The global data center market is expected to grow by somewhere between 10% and 20% over the next several years. IoT is projected to be a 25%-plus growth market over the next several years. Autonomous driving is pegged as a 40% to 60% annualized growth market over the next several years. IDC thinks the AR/VR market will grow at a 50%-plus rate over the next five years.
Nvidia has ample exposure to all of those markets. In this sense, Nvidia makes the chips that power tomorrow’s biggest growth markets. That gives NVDA stock both a big and diverse multiyear growth trajectory.
Declines over the past few months have dulled Nvidia’s previously sharp valuation. Whereas it used to trade at 33x forward earnings, Nvidia stock now trades around 20x future profits. We didn’t consider a 33x valuation too expensive considering Nvidia’s growth prospects, and we don’t consider its much more reasonable 20x valuation expensive either.
All in all, over the next several years, NVDA stock will continue to be a winner as investments into AI, data-centers and automation accelerate.
As of this writing, Luke Lango was long INTC and MU.
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