The Best Bet on Semiconductors

There’s a glut of semiconductors, so say bearish investors. They’re sort of right, yet it’s not what you think. It’s also the wrong way to look at the sector and its key businesses.

Executives at Advanced Micro Devices (AMD) announced on Tuesday that year-over-year Q2 sales and profits jumped 70.9% and 41.2%, respectively. However, an underwhelming Q3 outlook sent shares lower in after-hours trading.

Bears feel vindicated … ignore them. In fact, you should consider buying Cadence Design Systems (CDNS).

But before we get ahead of ourselves, let’s take a closer look at what’s really happening in the sector. There’s a lot to unpack here. The semiconductor space is at an inflection point, and it will never be the same again. The days of firms being stuck in their lanes and making generational microprocessors are over.

Well, that’s mostly true ...

Intel (INTC) and Micron Technology (MU) make chips according to the old business model. They build huge quantities of plug-and-play silicon that software developers build code around.

Unfortunately, this process makes those chips commodities. And make no mistake, there’s a glut of these chips. The markets they serve were overbuilt during the pandemic.

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Think about the millions of desktop and laptop computers companies bought for their employees to work from home.

That’s not the future of semiconductors, and it hasn’t been for a long time. Bears simply have not realized this, yet.

The best companies are now building chips around specific software needs … and that business is booming.

Apple (AAPL) may not be top of mind when it comes to semiconductors, yet software engineers at the Cupertino, California-based company rolled up their sleeves and built the best custom silicon available in laptop and desktop computers.

Alphabet (GOOGL) execs wanted a better chipset to run its complex AI algorithms, so the company continues to develop custom TPU chips. Amazon.com (AMZN) did the same for its network of data center servers. And the revolution doesn’t end with non-traditional semiconductor firms.

Forward-looking firms, like Qualcomm (QCOM), Marvell (MRVL), Broadcom (AVGO) and AMD, are designing bespoke silicon to help other companies run specific software applications, according to a report from Digits and Dollars.

If you’re interested in my personal picks in this sector, consider joining The Power Elite. Members are currently sitting on open gains of over 162.50%, 158.18% and 149.40%. They’ll be receiving my latest two picks in my next newsletter hitting inboxes this Friday at noon Eastern.

During her call with analysts on Tuesday, AMD CEO Lisa Su said that its data center business is extremely strong and there’s no slowdown in sight. Sales for these chips in the quarter surged 83% YOY, to $1.5 billion.

AMD is also making good progress in its embedded segment, where sales in the quarter were $1.3 billion. This business serves clients in automotive, industrial and advanced networking, like edge computing.

Cadence Design Systems makes software used by the semiconductor industry to design microprocessors and help with software integration. The business is extremely profitable from the ground up. Current gross margins are 90%, while operating margins are 28% and free cash flow is up 77% since 2020.

The San Jose, California-based firm is capably led by Lip-Bu Tan, a graduate of the nuclear engineering program at MIT. Tan is also the founder of Walden International, a venture capital firm that makes early stage investments in chip design firms, a facility that serves Cadence well.

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Relationship Science, a Silicon Valley analytics firm, has consistently named Tan among the most connected executives in tech.

Cadence touches every part of the semiconductor sector, small and large. The company builds the software those businesses need to scale new processes and integrate with ever-evolving software applications.

I began recommending Cadence in 2017 when shares were only $25.60. Since that time, shares have zoomed to $183.45, a sevenfold increase. These gains are certain to persist as the era of bespoke silicon leads to even more demand for design software. Just take a look at its technical chart …

 

It’s now popular to group all semiconductor companies in the same basket. Bears want to believe that a glut in the chips used in PCs translates to data centers and advanced networking. This is simply not the case.

Investors should consider buying Cadence shares to take advantage of the important differences one of them being all the profits you’ll be making while the bears sit on the sidelines.

As always, conduct your own due diligence before entering any trade.

Best Wishes,

Jon D. Markman

About the Editor

Jon D. Markman and team are winners of the Pulitzer Prize and the Gerald Loeb Award. He helped introduce Microsoft’s StockScouter, the world’s first online stock-screening system. And in the early 2010s, Jon correctly predicted the four major tech megatrends — mobile computing, big data, AI and AVs — that now dominate the world.

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