Investing in chip stocks: What are semiconductors?

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How many of these are in your life?

© Raimundas/stock.adobe.com

From the oldest calculator lying forgotten in your junk drawer, to the most advanced artificial intelligence (AI) software inconspicuously reshaping your (and everyone else’s) future, just about every electronic device in the world requires semiconductor microcircuits, aka microchips, or just plain “chips.”

Semiconductor chips are the building blocks of modern technology. They’re virtually everywhere, in just about every gadget that requires electrical flow. Given the critical role they play in industry, society, and everyday life, could the semiconductor industry represent a steady and robust investment?

Maybe. But it also helps to understand the fundamentals that can boost or slow the industry, including the aspects that present potential benefits and risks. It helps to know the factors that differentiate one chip producer from another. And it helps to understand the breadth and cyclicality of chip demand and what that might mean for the broader economy.

Let’s start with an important thing that people often confuse and conflate: the difference between semiconductors and chips.

A semiconductor is a material that has the capacity to regulate the flow of electricity. Its function falls somewhere between a conductor—which facilitates electrical flow—and an insulator—which limits or stops electrical flow. Think of it as a traffic controller for electricity.

When people talk about semiconductors, they’re usually not referring to the substance itself. Instead, they mean integrated circuit or “chip” products made with semiconductor material.

A semiconductor chip is an electronic device designed to provide the processing power, memory capacity, and other essential functions required to operate electronic gadgets.

Wall Street tends to use the two terms—semiconductors and chips—synonymously.

Semiconductors are ubiquitous. They power almost every technology across all industries in the global economy.

Not only does this diversify the chip industry’s sensitivity to the ebb and flow of economic cycles, but it also situates the chip industry in a position that drives economic growth. As chip production leads economic expansion, chip demand serves as a leading barometer for economic health.

Let’s start with revenue. In 2012, chip revenue worldwide stood just a little over $299 billion. In 2024, global chip revenue is expected to reach a whopping $630 billion, more than doubling its revenue in a little over a decade.

Currently, the top industries driving chip revenue growth are wireless communications and automotives. An electric vehicle (EV), for example, can use upwards of 3,000 chips in a single car. But almost every other industry you can think of also relies on integrated circuits.

Not only that, but chips are a key player in the production of emerging technologies such as artificial intelligence (AI), the Internet of Things (IoT), and 6G networks.

Let’s break down the entire global chip industry into two parts: design and manufacturing.

Semiconductor companies typically focus on designing chips or operating chip-manufacturing “foundries.” Most large chip companies don’t do both.

More than 70% of the world’s chips are manufactured in Taiwan, South Korea, Japan, and mainland China.

The global supply chain disruptions and product shortages resulting from the COVID-19 lockdowns in 2020, along with the U.S.-China trade war (and other challenges) in the years leading up to the pandemic, changed the way the U.S. perceived this delicate (im)balance in production.

The situation prompted U.S. lawmakers to work on bringing semiconductor production back “in-house” to decrease the risks of relying on offshore foundries. That’s what brought on the U.S. CHIPS and Science Act of 2022.

In the summer of 2022, artificial intelligence seemed like a technology that was still floating out on the horizon—a development that was inevitable, but still in the future. Fast-forward just a few months; in November of that same year, AI seemed to have permanently altered the course of the world in a way that was as surprising as it was sudden thanks to OpenAI’s ChatGPT, an AI chatbot exhibiting human-like language capabilities.

ChatGPT was trained on Nvidia (NVDA) graphics processing units (GPUs). So when the company reported its quarterly earnings in May 2023, noting surging demand for AI applications, Wall Street and the rest of the investing public rallied behind NVDA and other semiconductor and tech companies that were actively supporting AI development.

NVDA’s market cap hit the $1 trillion mark thanks to the massive surge in investment. As a result, along with communications and automotive applications, AI now appears to be a fast-growth segment for demand and production within the semiconductor industry.

Many semiconductor companies are increasingly focused on supporting AI functions. Four of the largest in the AI race* are Nvidia (NVDA), Advanced Micro Devices (AMD), Broadcom (AVGO), and Marvell Technology (MRVL).

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Figure 1: CHIPPING AT THE FUTURE. This price chart shows the relative performance of four semiconductor stocks competing in the AI space. NVDA (red line) leads the pack, as it became the first semiconductor company to attain a trillion-dollar market cap following its Q1 2023 earnings report and announcement of AI initiatives.

Source: StockCharts.com

Get ready to do a lot of homework. Chip production is a complex, time-intensive, and resource-heavy process that often crosses international borders to get things done. In addition, there are numerous companies in the semiconductor space, each occupying its own market position, producing its own products, and developing proprietary R&D initiatives. Assessing and comparing them takes a lot of work, but if you’re truly interested in investing in the chip industry, it may well be worth the effort.

Constantly scan the landscape. If analyzing chip companies is comparable to seeing the “trees,” so to speak, then understanding macroeconomic conditions, trade policies, and global tech trends would constitute the wider “forest.” Stay informed about the conditions and factors that can shift the semiconductor landscape.

Always diversify. A basic tenet in investing, diversification often means investing in different industries and sectors. But remember that you can also diversify within an industry. In the case of semiconductors, you can invest in a mix of smaller and larger companies, both domestically and/or abroad.

Consider ETFs. If you don’t have enough time to research semiconductor stocks, or if you don’t have enough capital to purchase a basket of different chip stocks to diversify, then you might consider investing in an exchange-traded fund (ETF) of semiconductor stocks. Just keep in mind that ETFs vary in their management fees and the stocks they include.

Semiconductors power the gadgets that make our present and shape our future. But before investing, you need to understand how the industry works, who the big players are, and how developments might affect various segments of the global economy. If you’re thinking of diving in, do your homework and keep up with global trends. And don’t put all your eggs in one basket—diversify your chip bowl by spreading your investments across different companies, or consider ETFs to make it easier.

*Specific companies and funds are mentioned in this article for educational purposes only and not as an endorsement.