Investment Ideas Beyond “Big Tech” Stocks

Many investors have enjoyed the sustained, unrelenting growth of large tech companies, often referred to as the FAANG stocks (Facebook, Apple, Amazon, Netflix and Google-parent, Alphabet). After this extended period of strong performance, they may find themselves over-exposed to this handful of stocks. As a result, investors could be in a risky position if FAANG growth rates slow or the companies encounter unforeseen headwinds.

As investors, we’re constantly looking beyond the companies grabbing all the headlines in search of compelling long-term investment opportunities. We believe we’re currently finding them in semiconductors.

Also known as microchips or chips, semiconductors are crucial to the underlying infrastructure of the digital economy. They power smart phones, cloud computing networks, electric vehicles, artificial intelligence, 5G communications and the Internet of Things. We expect newer technologies, like extreme ultraviolet (EUV) lithography, and clever chip architectures to accelerate innovation in the semiconductor industry. 

EUV Lithography Powers Leading Semiconductor Foundries

Netherlands-based ASML pioneered EUV lithography technology. This process uses a plasma-based laser to create billions of tiny structures on thin slices of silicon—each is 10,000 times thinner than a human hair. Together, they make up an integrated circuit, or chip. This technology enables chipmakers to pack more structures into a chip, which is critical in the development of next-generation semiconductors.

For example, leading foundries Taiwan Semiconductor Manufacturing Co. (TSMC) and Samsung are beginning to use EUV technology to make their highest performance chips. And Intel plans to follow suit over the next few years. We believe EUV will move the semiconductor industry forward in its quest to make chips smaller, cheaper, faster and more energy efficient.

New Chip Architectures Address Complex Computing Workloads

Back in 1965, Intel co-founder Gordon Moore hypothesized that the number of transistors incorporated into a chip would double every 24 months. “Moore’s Law” has started to bump up against the laws of physics. However, semiconductor companies are developing new architectures that nonetheless revolutionize the functionality of graphics processing units (GPUs) and central processing units (CPUs).

Answering the call for innovation, companies like NVIDIA have repurposed and retooled GPU products to be effective for specific uses, such as running artificial intelligence applications. The NVIDIA DGX A100 GPU, for example, gives the company significant opportunities to serve the data center market and complement its strong video gaming market share.

AMD, known for its processors and graphics cards for personal computers, is developing innovative chip designs to better compete against market leader Intel. AMD uses the chiplet design to develop better architecture—essentially separating its CPU into critical and noncritical pieces and then packaging them together.

It’s also important to note that value in the semiconductor industry is shifting away from general purpose chips and manufacturing to specialized semiconductors. For example, cloud computing companies are using their scale and cash to bypass traditional providers by designing their own chips and using external foundries, such as TSMC, to manufacture them.

Important Considerations for Tech Investing

After a long stretch of strong performance, the five largest tech companies account for about one-fifth of the S&P 500® Index.¹ We believe a high level of concentration such as this could be risky for any portfolio, but particularly for passive strategies that track the index. While we believe exposure to growth is needed, we have expanded our view to include innovative tech companies of all cap sizes.

In our portfolios, we take an active approach to managing risks and opportunities. When evaluating portfolio candidates in semiconductor industry, we’re considering companies with the qualities noted below.

• Revenue growth that persists through the ups and downs of market cycles

• Improving financial returns that generate strong free cash flow

• Smart capital allocation strategies

• Robust balance sheets that can fund growth initiatives and acquisitions

All investing involves risk and the potential for volatility. That’s certainly true when it comes to investing in semiconductor companies. Over the long-term, however, we think the industry offers upside potential.