Investing in semiconductor stocks can be a great addition to your portfolio. Semiconductor firms create and produce computer chips and related components. They are part of the technology sector, although chip producers are also in the industrial sector, which means their business is cyclical.

In the industry, picking top-performing semiconductor stocks might be difficult, and their performance is highly volatile owing to sales fluctuations. However, the sector is expanding quickly due to COVID-19’s introduction of a digital-first world. In fact, Intel (NASDAQ:INTC) recently predicted that worldwide spending on semiconductors will reach $1 trillion per year by the end of the decade, roughly double where it is now.

These technological building blocks deserve investors’ attention.

What drives semiconductor stocks?

Up-and-coming semiconductor firms will likely focus on two areas of development in the coming decade::

  • Connectivity and mobility: Self-driving vehicles and 5G mobile networks belong here.
  • Computing accelerators: Graphics processing units (GPUs), which are in demand by gamers and cryptocurrency miners, are in demand.

In 2020, the United States, accounted for about half of the $440 billion worldwide semiconductor investments. Semiconductor chips are now the nation’s fourth-largest export from a global perspective. One-fifth of semiconductor manufacturing spending are devoted to research and development spending. As a result, these tiny mechanical parts are responsible for many technological breakthroughs in other sectors of the economy.

Identifying the best semiconductor stocks

Consider these four critical factors while looking for the best chipmakers and long-term undervalued semiconductor stocks to buy:

Sustainable revenue growth

The best investments are those that gradually improve their sales over time. But, overall revenue growth is even more critical for semiconductor stocks.

Many firms in this industry are having difficulty dealing with the cycle. Over time, computer chips become a commodity. If a new market is expanding rapidly, other chipmakers respond by launching comparable goods. As a result, supply grows, prices fall, and company sales drop due to more supply and decreasing costs. If a semiconductor chip firm does not constantly develop new outlets for its hardware technology and innovate to stay afloat amid the cycle, it may be unsustainable over time.

Above-average profit margins

However, it is important to note that sales don’t automatically equal profits. Companies with uncontrollable expenses have low-profit margins. Furthermore, companies with high-profit margins can reinvest in research and development and improve their operations. High net income, operating profitability, and free cash flow generation are all signs that the firm is running efficiently.

Attractive returns on invested capital

A firm’s return on invested capital (ROIC) indicates how effectively it can make money from the cash it borrows and the equity it receives. In addition, a high ROIC shows that the company is likely to be innovative and improve operations to increase efficiency.

Strong balance sheet

Semiconductors are frequently costly to produce. Therefore it’s critical to understand how chip firms in this sector acquire the financial resources required to develop. First, look at a firm’s debt ratio against operating profit and cash on hand to see if it’s well-funded. Even if the debt looks concerning, having a lot of money relative to debt suggests that a business can make interest and principal payments even in an emergency.

Should you buy semiconductor stocks?

The performance of semiconductor stocks is unpredictable. The semiconductor business is complicated, with hundreds of processes required to produce the most advanced circuit technology and dozens of firms involved in fabricating the equipment used to create semiconductors chips.

Even the most promising firms in the sector are prone to volatility; therefore, investing in top-performing semiconductor stocks entails a certain amount of risk. However, as demand for semiconductor chips grows over time, investing in these technology’s fundamental components will almost certainly be lucrative.

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