Cash in on chips with companies harnessing the future of technology
A professional investor tells us where he would put his money. This week: Matthew Page, fund manager, Guinness Global Innovators Fund, highlights his favourites
The Guinness Global Innovators Fund focuses on firms able to grow profitably and boasting sustainable competitive advantages that lead to high returns on capital both today and in the future. We like companies with high levels of recurring revenues, a global opportunity and pricing power. We seek to filter out short-term fads and hype and instead focus on firms whose valuations do not take into account their growth potential. We select 30 stocks and tend to hold them for the long term. For example, we have owned chip giant Nvidia for more than 15 years.
While Nvidia has been grabbing the headlines over the past 18 months, semiconductors jumped out to us as an area of interest in 2018. Historically, many semiconductor companies have had very cyclical earnings profiles, but we thought that cyclicality was likely to be dampened in the future and growth prospects were likely to increase. Following three years of very strong revenue growth amid the pandemic, the semiconductor industry did face a downturn during 2023 – the seventh since 1990. But semiconductor stocks outperformed the broader market.
While we are certainly bullish on the long-term outlook for semiconductor stocks, our overweight position is a result of our bottom-up stock selection. Our six semiconductor holdings are exposed to many of the growth themes we have identified and boast the growth, quality, and valuation characteristics we seek. They include three of the semiconductor-equipment manufacturers, an area set to benefit from both the wider application and increasing complexity of chips, raising the requirements of the equipment used to manufacture them.
One-stop chip shop
Applied Materials (Nasdaq: AMAT) is the largest semiconductor equipment manufacturer by sales. It covers most of the chip-fabrication process and is the leader in several segments, offering diversification and real-time insight into customers’ needs. AMAT has peer-leading levels of research and development (R&D) and a range of solid competitive advantages. Valuation multiples have risen, but management expects operating margins to expand, which should facilitate robust earnings growth.
Lam Research (Nasdaq: LRCX) also boasts wide coverage of the fabrication process and is a leader in different segments. It benefits from relatively high recurring revenue from servicing its installed base of equipment. Margins, already at robust levels (net margin 22%), are expanding. Its wide-ranging expertise and R&D expenditure reinforce its competitive position against more focused rivals such as KLA Corporation (Nasdaq: KLAC).
KLA dominates the process-control segment, used to detect defects in the semiconductor fabrication process. KLA boasts a wide economic moat (an enduring competitive advantage that deters potential rivals), thanks to its proprietary technology. It also benefits from strong relationships with customers, allowing it to generate high recurring revenues from the largest global foundries, for whom switching costs are high. Gross margins have exceeded 50% and revenue growth is expected to reach 5% annually until 2030.
A risk factor for all three companies is high exposure to China, potentially exposing them to trade disputes, while the size of chip manufacturers such as TSMC leads to a degree of customer concentration. All three benefit from increasingly diverse markets with strong long-term growth prospects such as artificial intelligence (AI), cloud computing and mobile technology, leading to lower sales volatility.
“All three rms bene t from trends such as AI and cloud computing”