SOXX: Assessing The Value Of Semiconductor Stocks One Year Later

Summary

• SOXX offers market-cap-weighted exposure to 30 semiconductor and semiconductor equipment stocks. With a 22-year history, this ETF has amassed $8.66B in assets under management.
• SOXX is on fire this year, up over 40% primarily due to improved guidance from big players like Nvidia.
• However, SOXX's overall fundamentals are weaker compared to a year ago when I issued a strong buy recommendation for SOXQ, a lower-cost alternative.
• Consequently, I've rated SOXX a hold today, and recommend readers take short-term profits until valuations normalize.
• Looking for a portfolio of ideas like this one? Members of Hoya Capital Income Builder get exclusive access to our subscriber-only portfolios. Learn More »

Laurence Dutton

Investment Thesis

One year ago, I issued a "strong buy" recommendation for the Invesco PHLX Semiconductor ETF (SOXQ), rationalizing that its relatively cheap valuation, high growth rate, and anticipated government aid through the CHIPS and FABS Acts made it high-reward play in the volatile Technology sector. In hindsight, my recommendation was too early. SOXQ fell 25% four months later, and although it eventually recovered to outpace the Invesco QQQ ETF (QQQ) and the SPDR S&P 500 ETF (SPY) since June 2022, the recovery only occurred this year. Still, I don't consider it a successful call because the Technology Select Sector SPDR ETF (XLK) provided investors with a much less bumpy ride and a 2.36% higher return.

Portfolio Visualizer

Today, I will exercise more caution as I review the iShares Semiconductor ETF (NASDAQ:SOXX), which has almost the same profile and holdings as SOXQ. Due to Nvidia (NVDA) trading at 51x forward earnings, relatively negative sentiment on Wall Street for semiconductor stocks, and a below-par Q1 earnings season for most of SOXX's constituents, I have downgraded my rating to a hold. Now is an excellent time to take profits, and I look forward to walking you through the latest numbers in more detail below.

SOXX Overview

Strategy and Performance

SOXX tracks the ICE Semiconductor Index, comprised of 30 U.S. companies that design, manufacture, and distribute semiconductors. The Index is free-float market-cap-weighted and is the largest U.S. semiconductor-focused ETF today, with $8.66 billion in AUM and a 0.35% expense ratio. The expense ratio is high, and SOXQ's 0.19% represents a better deal for what is a very close alternative. I've listed five others below for you to consider, but for plain-vanilla exposure, SOXX and SOXQ are solid choices.

• First Trust Nasdaq Semiconductor ETF (FTXL): Multi-Factor, Factor-Weighted
• Invesco PHLX Semiconductor ETF (SOXQ): Vanilla, Market-Cap-Weighted
• Invesco Dynamic Semiconductors ETF (PSI): Multi-Factor, Tiered Weighting
• SPDR S&P Semiconductor ETF (XSD): Equal-Weighted
• VanEck Vectors Semiconductor ETF (SMH): Vanilla, Market-Cap-Weighted

SMH is another plain-vanilla fund to consider. It's an easy way to gain more access to Taiwan Semiconductor Manufacturing (TSM), as its exposure in SMH is 11.28% compared to 3.52% in SOXX. Fees are the same at 0.35%.

SOXX has a decent long-term track record. Since XSD's inception in January 2006, SOXX delivered a 13.61% annualized gain compared to 13.79%, 13.36%, and 14.09% for SMH, XSD, and XLK.

Portfolio Visualizer

The downside is higher volatility, a factor I should have assigned more weight to in my previous review of SOXQ. If market sentiment turns negative and earnings estimates contract, then it doesn't matter how attractive an ETF's growth/valuation profile is. Volatile ETFs like SOXX and SOXQ will decline, and as demonstrated earlier, it can take some patience for the play to pay off. Still, SMH, XSD, and XLK outperformed for the year ending April 2023.

Portfolio Visualizer

SOXX Top Ten Holdings

SOXX's top ten holdings total 62% of the portfolio and are listed below. Nvidia leads with an 11.56% allocation, followed by Broadcom (AVGO), Advanced Micro Devices (AMD), and Texas Instruments (TXN).

iShares

Nvidia's market cap is nearing $1T after management issued "jaw-dropping guidance last week, leading analysts to boost future earnings estimates substantially. Seeking Alpha's EPS Revision Grades reflect these movements, as Nvidia's Grade improved from "B-" to "A-" after its earnings reports. It's easy to see why based on the earnings estimate trends below.

Seeking Alpha

Still, we should remember that Nvidia is just one holding in SOXX, and several of its 29 other holdings (88% of the weight) look less impressive. Therefore, let's take a closer look at SOXX's fundamentals.

SOXX Fundamental Analysis

The following table highlights selected fundamental metrics for SOXX's top 25 holdings, totaling 98% of the portfolio. To illustrate the changes from one year ago, I also included previous metrics for SOXX and XLK and current ones for SOXQ, QQQ, and XLK.

The Sunday Investor

As mentioned earlier, my previous "strong buy" recommendation was based on several factors, including:

• An excellent estimated sales and earnings growth rate relative to XLK, which was 7-8%% less at 20.04% and 22.34%
• A cheap 18.72x forward earnings valuation, or about a 7-point discount
• Attractive earnings revision scores vs. XLK (6.91/10 vs. 6.03/10)

In addition, I figured increased government funding would support an industry deemed crucial to U.S. national security. Unfortunately, I didn't anticipate the sharp decrease in earnings revision scores for the entire market (SPY bottomed at about 4.75/10), supported by weak earnings surprises among most Technology stocks, including those in the semiconductor industry.

The table above highlights how much things have changed over the last year. Unfortunately, the changes look for the worse. Consider these statistics:

1. SOXX has a 1.41 five-year beta compared to 1.27 previously. Since we've only had one quarter of above-average earnings surprises, it's possible SOXX's recent gains could reverse with a bad Q2 earnings season.

2. SOXX's growth advantage over XLK has disappeared. The ETF now trails by 2% on estimated earnings growth (8.05% vs. 10.08%) but retains a small premium on estimated sales growth (9.92% vs. 9.54%).

3. Similarly, SOXX trades at a slight discount on forward earnings to the better-diversified XLK (29.52x vs. 30.58x).

4. SOXX's most recent quarterly earnings surprise is only slightly better than XLK's (8.26% vs. 7.68%), and contrary to Nvidia's situation, Wall Street analysts are not optimistic about most of the other 88% of the portfolio. SOXX's weighted average EPS Revision Grade is only 5.17/10 vs. 6.28/10 for XLK. The table below details additional earnings season results.

The Sunday Investor

I provided median values to highlight how different the market is treating the smaller semiconductor companies versus the better-known players. Interestingly, the median price-earnings ratio is only 19.94x, while the weighted average is nearly ten points higher at 29.52x. Much is due to Nvidia, which trades at 50.73x forward earnings. However, AMD and Marvell Technology Group (MRVL) valuations are also elevated at 44.08x and 42.77x. As part of Marvell's latest earnings release, its CEO wrote:

AI has emerged as a key growth driver for Marvell, which we are enabling with our leading network connectivity products and emerging cloud optimized silicon platform. While we are still in the early stages of our AI ramp, we are forecasting our AI revenue in fiscal 2024 to at least double from the prior year and continue to grow rapidly in the coming years."

Marvell isn't alone in using AI to catapult its stock price by 72% in just one month. According to Reuters, Nvidia management mentioned "AI" 86 times on its latest conference call, beating out both Alphabet (GOOGL) and Microsoft (MSFT). Wall Street analysts are to blame, too, often asking questions about AI and perhaps inadvertently adding to the hype.

These larger companies are doing the heavy lifting. SOXX's weighted average one-month price return is 24.31% compared to the 13.67% median. If earnings expectations do not pan out over the next year, SOXX is at massive risk of declining even more than the 25% drawdown experienced last year.

Investment Recommendation

SOXX's fundamentals are weaker than one year ago, and investors should consider taking profits on semiconductor stocks today. SOXX trades at 29.52x forward earnings, features a relatively low 8.05% estimated earnings growth rate, and is supported primarily by the sizeable recent price increases of mega-cap stocks like Nvidia. Besides, XLK still offers 26% exposure to semiconductor stocks, and its lower volatility, higher earnings growth, and increased diversification will likely help you sleep better at night. For Technology investors, that's the smarter play right now. Thank you for reading, and I look forward to the discussion in the comments section below.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of SPY, SOXQ, MSFT either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

I/we plan on exiting a long position in SOXQ over the next 72 hours.

Comments

[The Sunday Investor]

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[Ron1634]

I bought a bunch of individual semiconductor stocks on sector weakness in the Fall of 2022, but even then SOXX just seemed too expensive.
I kind of regret that decision.
Maybe I will get it in the next Bear market.