Investing in Microchip Stocks

Microchip companies design and manufacture the basic components that make computing systems. Microchip businesses are part of the technology sector, but they are also advanced engineering and manufacturing companies. As chips proliferate throughout industries, the producers of these basic tech building blocks are becoming an increasingly important part of the global economy.

As with any business closely tied to manufacturing, the microchip industry (also referred to as semiconductors, or simply as chips) is a cyclical one. Booming sales are often followed by sharp slowdowns. Nevertheless, top companies in this space have produced some incredible market-beating returns over the long term and deserve investor attention.

Investing in microchip stocks

Tech researcher Gartner (NYSE:IT) has estimated that revenue from the chip industry in 2021 grew 25% from the previous year, surpassing $580 billion worldwide. Estimates have global semiconductor spending reaching $600 billion in 2022.

A global chip shortage has helped prop up prices. Demand is also soaring as developments in everything from household appliances to autos to data centers increase the need for various microchips and electronic components.

Chip manufacturers with fabrication plants (known as “fabs”) are spending billions to ramp up production. Although sales from one year to the next can be volatile, there is massive growth potential in the decade ahead. Some estimates suggest global microchip sales and related spending could reach $1 trillion by the end of the 2020s.

With that in mind, here are seven microchip stocks (from chip designers to fabs to fab equipment developers) to consider for 2022 and beyond:

1. Taiwan Semiconductor

Slowly but surely, Taiwan Semiconductor has built itself into the world’s largest manufacturer of microchips. It took the crown from Intel (NASDAQ:INTC) a number of years back, and steady investment in increasingly advanced chip fab capabilities has paid off. Its fabs (most of which are in Taiwan, but there are a number elsewhere, including the U.S.) can handle the most complex chip designs around. Taiwan Semiconductor boasts more than half of the total market share of chip fabrication.

As a manufacturing giant, Taiwan Semiconductor would normally be considered a highly cyclical stock. Many manufacturers, including fellow chip fabs, are prone to ebbs and flows in sales from year to year. But Taiwan Semiconductor’s constant investment in new and advanced production has kept demand steadily rising for years. Over the past decade, the chipmaking giant has gone from just $17 billion in annual sales to almost $57 billion in 2021. Sales continued growing at a double-digit percentage pace in 2022.

Taiwan Semiconductor has managed to maintain an operating profit margin of no less than 30% over the past 10-year stretch. The company is still reinvesting to maintain its production prowess and also pays a modest dividend to shareholders. If you’re looking for a long-term play on microchip expansion, Taiwan Semiconductor is a good place to start.

2. Nvidia

Nvidia has quickly become one of the most recognizable names in the semiconductor business. The company got its start as a developer of specialized chips called GPUs (graphics processing units) used for high-end video games. The company has remained true to its roots, and almost half its revenue still comes from its video game segment, which is a ubiquitous form of entertainment around the world.

However, Nvidia has spurred a revolution in computing by extending the usefulness of GPUs beyond games. Nvidia hardware now powers artificial intelligence (AI) for businesses via its data center chip designs. Data centers are now its second-largest segment by revenue. The company has extended its tech even further and is powering devices with computing intelligence. This includes robotics in factories and warehouses, self-driving car features for automakers, and medical devices and research.

More than just a microchip company, Nvidia recently made a foray into software with subscription services that enable AI-fueled applications built atop its leading GPU business. Nvidia is a premium-priced stock among its chip peers and for good reason. It is one of the most promising companies in the AI computing movement.

3. Broadcom

Broadcom is not a household name. However, the chip giant is quietly helping to power everything from 5G mobile network development to data centers and industrial equipment. As its name suggests, it supplies a broad range of electrical parts and components that companies need across many sectors of the economy.

Although Broadcom is not the highest-growth chip business on this list, it has expanded slowly and steadily for years. What it lacks in high-octane growth, it more than makes up for in profitability. The company generated a whopping free cash flow profit margin of almost 49% in 2021. Acquisitions have been key to Broadcom achieving this profitability. It reached a $61 billion deal to acquire cloud computing infrastructure giant VMware (NYSE:VMW) in one of the largest mergers so far this decade.

Broadcom has a policy of returning about half of the free cash flow it generated the previous year to shareholders via dividends, and it supplements dividends with share repurchases. If you’re looking for investment income from a microchip stock, Broadcom might be your ticket.

4. Qualcomm

Qualcomm was a darling of the chip industry during the 2000s and 2010s, riding the wave of mobility as smartphones went from a novel idea to a part of everyday life. The smartphone market has matured and isn’t as much of a high-growth industry anymore. The development of 5G mobile networks, however, is breathing new life into Qualcomm.

Qualcomm isn’t just a smartphone microchip designer. Almost every mobile phone on the planet has a piece of Qualcomm silicon in it, so a flood of 5G phone upgrades is lifting the company’s revenue higher. But Qualcomm has diversified its business in recent years. It also designs parts for the network equipment used to create mobile signals, as well as industrial connectivity devices and a nascent auto technology segment. Each of the new businesses will also benefit from new 5G networks.

Qualcomm has a tight grip on the global mobile market, and it’s using its strength to expand its scope of work. As it does so, the company is finding new ways to rekindle its revenue growth. It has established itself as a leader in new areas such as connected autos, smart home devices, and industrial equipment.

5. Texas Instruments

Texas Instruments has a long history in the industrial microchip space. The company designs and manufactures digital and analog electronic components for consumer devices, autos, aerospace and defense equipment, and communications networks.

This is another slow-but-steady growth name in the chip business. However, Texas Instruments prides itself on reinvesting in operations to increase its manufacturing efficiency and boost free cash flow. It’s averaging an annual free-cash-flow-per-share increase of 12% since 2004. Its longstanding policy is to return excess cash to shareholders by way of dividends and share repurchases.

The result has been a fantastic chip investment that has steadily increased both its share price and dividend payout for almost two decades. If you love dividend stocks that consistently increase their payout, Texas Instruments is the semiconductor company for you.

6. Advanced Micro Devices

Advanced Micro Devices (known as AMD) has always played second fiddle to Intel. But more than a decade ago, AMD offloaded its chip fab segment -- now GlobalFoundries (NASDAQ:GFS) -- to focus solely on chip design. The move has paid off. Although AMD is still far smaller than Intel, it has been picking up serious market share in the personal computing space.

Data centers -- the basic computing units of the cloud -- have been an especially lucrative market for AMD. CPUs (central processing units), an integral part of data centers, are in increasing demand as remote work has become more common and services delivered via the internet become routine. AMD has won over lots of customers with its leading microchip designs, benefiting both from a secular growth industry and taking market share from long-time rival Intel.

As it has grown, AMD has also gotten more efficient. Just a few years ago, the company still struggled during slow years and would frequently report steep operating losses. But the new AMD is highly profitable (it posted an operating margin of 22% in 2021). Its recent megamerger with Xilinx is lifting profit margins even higher, giving AMD room to invest more aggressively in research and development. Once an underdog, AMD is now a top name in the computing business.

7. Applied Materials

Applied Materials is neither a chip designer nor a manufacturer. However, the company has a deep understanding of microchips, how they’re made, materials used to make them, and how they fit into an overall computing system. Its understanding of microchips has helped Applied Materials become a top developer of equipment that chip fabs need to manufacture electrical components.

Chip fab equipment has been consolidated into a few major companies over the years. ASML Holding (NASDAQ:ASML) and Lam Research (NASDAQ:LRCX) are two other major players. The consolidation has made Applied Materials an almost surefire bet if you think semiconductor demand will continue to rise over the next decade or two. When a chip manufacturer announces plans to update or expand a plant, or break ground on a brand-new one, there’s a really good chance Applied Materials will be selling them some equipment. The company also has a sizable recurring revenue stream from ongoing service to equipment purchased by customers.

Thanks to industry consolidation, Applied’s business model has become far less cyclical than in times past. Revenue has been steadily on the rise for years and so have profit margins; the company’s operating profit was more than 31% in 2021. Many countries are trying to establish more localized chip fabrication capabilities because of the COVID-19 pandemic. This is great news for companies such as Applied Materials since they have a large backlog of orders for their equipment. This helps to make the company’s stock a good way to invest in microchip fabrication growth in the coming years.

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A basic commodity of the digital era

Microchip demand is exploding in the wake of the pandemic. Computing technology growth was already happening. But an acceleration in the trajectory of adoption has taken place as everything from new car models to industrial equipment needs more chips. As tech proliferates throughout the economy and creates more efficiency, semiconductors are quickly becoming a basic commodity for the digital era.

Investing in microchip stocks holds a lot of promise as a result. But, as is the case with all tech, be mindful to invest for the long term (three to five years at least, but the more, the better). Also be sure to diversify your holdings among a number of top names in the space. There will be curveballs at times, but the microchip industry is poised to enjoy strong growth for many years to come.