iShares PHLX Semiconductor ETF Is Expensive, But Long-Term Growth Outlook Appears To Be Favorable

ETFS

ETF Overview

iShares PHLX Semiconductor ETF (NASDAQ:SOXX) owns a portfolio of large-cap semiconductor stocks. The fund seeks to track the investment results of the PHLX Semiconductor Sector Index. Stocks in SOXX’s portfolio should continue to enjoy favorable industry fundamental as the semiconductor industry is set to grow at a rate of 7.67% annually through 2024. In addition, stocks in SOXX’s portfolio have a competitive position over their peers with moderate financial strength. However, these stocks are quite expensive than their historical averages. Therefore, we do not think the current risk and rewards profile is attractive. We think investors may want to wait on the sideline until a pullback.

ChartData by YCharts

Fund Analysis

Semiconductor industry will benefit from several technological trends in the next decade

SOXX’s portfolio consists of 35 semiconductor stocks. These companies include integrated circuits design companies, foundries, DRAM and memory manufacturers, and semiconductor equipment providers. Semiconductor components are essential electronic components that consumers need in everyday lives. The industry is set to continue to grow at a fast pace, thanks to evolving Internet of Things, increasing electronic content in vehicles, artificial intelligence, 5G, and the need for data centers in the next decade. As can be seen from the chart below, the global semiconductor market is expected to grow from $536 billion in 2018 to $831.5 billion in 2024. This represents a compound annual growth rate of 7.67%. Therefore, we think stocks in SOXX’s portfolio will continue to benefit from these technological trends in the next decade.

Source: Statista 2019

Below is a chart that shows semiconductor revenue growth by electronic equipment type in the next few years. As can be seen from the chart, growth is broad-based across different categories. Notable areas of growth include wearable devices (e.g. head mount display, smartwatches), electric vehicles, security, and other industrial applications.

Source: Deloitte Analysis

SOXX’s portfolio of stocks are moaty stocks with high barrier to entry

Most stocks in SOXX’s portfolio are large-cap stocks that have sizable market shares in their areas of strength. Indeed, stocks in SOXX’s portfolio are companies with moats. Most of these stocks either hold key important intellectual properties, or manufacturing know-hows (with patents) that are difficult for its competitors to replicate in a short period of time. Although financial strengths are only moderate for most of the top 10 stocks in SOXX’s portfolio, we understand that this is a capital-intensive industry.

Morningstar Moat Status

Morningstar Financial Strength

% of ETF

Nvidia (NVDA)

Narrow

Moderate

8.19%

Texas Instruments (TXN)

Wide

Strong

7.96%

Qualcomm (QCOM)

Narrow

Moderate

7.85%

Intel Corp. (INTC)

Wide

Moderate

7.46%

Broadcom (AVGO)

Narrow

Moderate

7.06%

Advanced Micro Devices (AMD)

None

Moderate

4.57%

Micron Technology (MU)

None

Moderate

4.39%

Lam Research (LRCX)

Narrow

Moderate

4.08%

Taiwan Semiconductor Manufacturing (TSM)

Narrow

Strong

4.08%

NXP Semiconductors (NXPI)

Narrow

Moderate

4.07%

Total:

59.71%

Source: Created by author

SOXX is expensive now

SOXX has delivered an excellent total return of 473% in the past 10 years. This is much better than the S&P 500 Index’s total return of 247%. As a result of the price appreciation, SOXX’s forward P/E ratio of 21.08x is now much higher than the S&P 500 Index’s 18.75x. Similarly, SOXX’s price to cash flow ratio of 10.85x is also higher than the S&P 500 Index’s 10.33x.

SOXX

S&P 500 Index

Forward P/E Ratio

21.08x

18.75x

Price to Cash Flow Ratio

10.85x

10.33x

Sales Growth (%)

13.70%

7.06%

Source: Morningstar, Created by author

Let us now take a look at SOXX’s top 10 holdings. The average forward P/E ratio of SOXX’s top-10 holdings is now 23.19x. This is significantly higher than its 5-year average P/E ratio of 18.01x. Therefore, we think SOXX’s valuation is expensive.

Forward P/E

5-Year Forward P/E

% of ETF

Nvidia

33.90

29.89

8.19%

Texas Instruments

24.39

20.02

7.96%

Qualcomm

21.60

14.21

7.85%

Intel Corp.

12.36

12.50

7.46%

Broadcom

13.21

13.06

7.06%

Advanced Micro Devices

46.51

33.12

4.57%

Micron Technology

24.10

9.44

4.39%

Lam Research

20.16

13.47

4.08%

Taiwan Semiconductor Manufacturing

22.88

17.01

4.08%

NXP Semiconductors

15.72

14.02

4.07%

Weighted Average/Total:

23.19

18.01

59.71%

Source: Created by author

Risks and Challenges

Investors should keep these risks keep in mind:

Semiconductor industry is highly-cyclical

Semiconductor industry is highly cyclical. Even though stocks in SOXX’s portfolio are large-cap or giant-cap stocks, they will likely face sales decline when supply exceeds demand. In fact, the semiconductor industry was on a downward cycle in the first half of 2019.

China represents about 41% of the total semiconductor demand in the world

In 2018, China’s semiconductor consumption accounted for 41% of the global total consumption. According to a research by Deloitte, China is expected to account for 57% of global semiconductor consumption by 2024. While this market should continue to grow, we think risk is high. This is because trade uncertainties between the U.S. and China may evolve into a tech war. This is already evident in the fact that the U.S. imposed sales ban on Huawei products and restrict U.S. companies from selling many high-tech equipment and products to China. Therefore, the actual global semiconductor sector revenue growth rate may be lower than the forecasted growth rate.

Investor Takeaway

Stocks in SOXX’s portfolio should continue to grow over the next decade, thanks to several important technological trends. However, these companies are quite expensive right now. We think investors may want to stay on the sideline.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.

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