There are some valid reasons why I feel that investors should avoid microchip stocks this year. Although the long-term potential of these companies is solid, in the short-term, they could underperform the broad indices such as the Nasdaq, thus leading to disappointing results for bagholders.
Let’s explore the operational and strategic hurdles that could shape the industry’s trajectory in the near future. We will cover the issues from three different angles. The first two are the economic and market challenges and the industry-specific risks. And finally, we’ll examine the operational and strategic issues that are holding these companies back from being strong performers this year.
So here are the three reasons to avoid microchip stocks today and in the near future.
Economic and Market Challenges
There are several economic uncertainties right now that make microchip stocks unappealing. To name a few problems plaguing the industry, the automotive and industrial sectors are experiencing a pullback due to high interest rates and uncertain product demand. Those industries are significant consumers of microchips.
Then, there are the broader economic weaknesses, particularly in regions such as Europe. This continent is grappling with unusually high inflation and energy price fluctuations due to the ongoing war in Ukraine. Although these are indirect factors, they do form a large backdrop for companies that serve clients in this region, resulting in increased product inventory and delayed shipments.
Finally, microchip stocks are already cyclical companies that are sensitive to changes in geopolitical climate, interest rates, and global economic growth. These factors might be stronger than normal due to the current tough macroeconomic environment, which could put even more pressure on these companies in the near term.
Valuation and Company-Specific Headwinds
Investors don’t need to infer that the semiconductor industry is having a tough time. Companies like Intel (NASDAQ:INTC) are forecasting revenues significantly below market estimates, reflecting struggles with consumer demand.
Then, investors are concerned that some semiconductor stocks like Advanced Micro Devices (NASDAQ:AMD) may be overvalued. This raises eyebrows about its ability to continue to deliver capital growth to investors moving forward. For some context, AMD stock trades at 330.63 times earnings, which is significantly above its 3-year average of 161.18.
A troubling backdrop and irrational bullishness make investing in these marquee brands risky. Further, it seems likely that there will be a correction in their stock prices.
Concurrent risks in the semiconductor industry punctuate these risks. Namely, there is shifting importance from areas like 5G to artificial intelligence (AI). This could adversely influence how trendy investing in microchip stocks will be for the foreseeable future.
High Inventories and Reduced Fabrication Utilization
Also, semiconductor stocks must navigate crucial operational and strategic weaknesses. As reported by Deloitte, inventories remained high at more than $60 billion as of fall 2023, similar to the previous year’s level.
Additionally, fab utilization, which was high during the recent shortage period, was expected to drop below 70% in Q4 2023. I expect this to persist throughout Q1 2024. Also, it appears unclear how the industry will pick up steam amid the many problems that the industry faces. An increase in fab utilization is required in order for these companies to deliver strong profits to shareholders.
Therefore, the semiconductor industry is suffering and seems primed to be an underperformer for FY2023. For these reasons, I recommend that investors avoid this industry until there are clear signs that the macroeconomic environment has improved. Also, this includes signals and guidance from executives from companies like AMD and Intel.
On the date of publication, Matthew Farley did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
