Semiconductor stocks have outperformed all other industry groups for the past decade, and we see scope for continued outperformance; however, given a wide range of business models and competitive advantages, there is no one-size-fits-all investment thesis. Here’s how we think about the industry.
Factors Driving Outperformance
Sometimes referred to as integrated circuits (ICs) or microchips, semiconductors are the brains of modern electronics and enable innovation across industries, and they have been compelling investments.
There are more than 9,000 stocks in the MSCI ACWI IMI, with just 275 (3%) from the semiconductor industry. Yet over the past 10 years, semiconductors made up 40% of the 10 best-performing stocks. 
If the last three years have taught us anything, it’s that the future is very difficult to predict. New applications are always emerging.
One reason for semiconductor outperformance is their strengthening competitive advantages—increased barriers to entry alongside rapid innovation, rising complexity, and greater capital requirements.
Industry consolidation is also a factor. Mergers and acquisitions have accelerated economies of scale. With certain parts of the value chain dominated by just a handful of large companies, it’s nearly impossible for new entrants to be competitive.
Lastly, structural demand has contributed to semiconductor outperformance. The growth story is no longer limited to personal computers (PCs) and phones. Chips are critical to products across end-markets, from consumer to healthcare, automotive to industrials.
Structural Growth Underestimated
As we previously wrote in this blog post, we see four key growth drivers for semiconductors: digitalization, deglobalization, content gains, and leading-edge demand. Deglobalization and its impact on semiconductor supply and demand was also discussed in a recent episode of The Active Share podcast.
Despite these growth tailwinds, semiconductor industry revenue growth is consistently underestimated, in our opinion. Why? Historically, two big applications accounted for the majority of incremental growth. First it was PCs. By the time that market reached saturation, smartphones took over. As each product reached the end of its growth curve, it was easy to conclude that semiconductor growth had peaked. But if the last three years have taught us anything, it’s that the future is very difficult to predict. New applications are always emerging.
In addition, the composition of chip buyers is becoming more diverse, leading to strength across the spectrum—from advanced chips enabling 5G networks and cloud-based artificial intelligence (AI) to more mature technologies, such as the sensors found in thermostats and other smart home products.
In particular, we expect semiconductor content per device to accelerate in automotive, industrial, and various “high-performance computing” applications such as AI over the next three to five years. The number and complexity of chips has been rising as the cost of chips has been declining.
The chart below shows semiconductor industry revenue by application, along with a 10-year growth forecast. The key takeaway is that smartphones still drive a significant proportion of overall chip revenue, but we believe the automotive and industrial end-markets could be among the fastest-growing verticals.
All semiconductor companies are not the same, and the chart below gives some color as to why it’s sometimes difficult to contextualize them. It’s a complex industry. It’s fast-moving. It serves numerous markets, as we mentioned.
When developing an investment thesis, we believe it’s important to look at the opportunity set in several ways, one of which is by business model. Semiconductor businesses span the range of capital intensity, from software-like chip design to outsourced manufacturing, where a single company may dedicate more than 50% of revenue to capital expenditures.
High capital intensity typically equates to volatile fundamental performance. There is a mitigating factor, though—the risk of market instability tends to be lower.
Business models aside, end-markets can inform the nature of revenue growth. Consumer electronics are characterized by fast product cycles and higher cyclicality, whereas the automotive and industrial verticals have lower, but more resilient (less cyclical), growth.
Revenue growth in automotive and industrial semiconductors tends to be more durable over a long period of time. Longer design cycles are often associated with stickier customer relationships, less competitive disruption, and better economic returns. That’s a pretty good fit for long-term investors, in our opinion.
As you can see, a mosaic of attributes and indicators guide our semiconductor investment decision-making. But nothing is set in stone; we are always on the lookout for what might change our existing views.
Technological disruption is always top of mind. This may include the adoption of new architectures, different materials, or changes to manufacturing capabilities.
Identifying compelling long-term investments requires intellectual curiosity and an open mind.
As an example, computers using quantum physics instead of traditional semiconductor architectures have performance capabilities and processing power that’s far greater than classic computers. Quantum computing has the potential to transform everything from technology to healthcare.
Beyond technology-led changes, geographic capacity expansion in response to national security concerns and increased government intervention could lead to lower asset utilization for chip manufacturers, putting downward pressure on profit margins and returns on capital. With less money for foundries to reinvest in research and development and capital expenditures, we may see a slowdown in technological innovation and more subdued growth for certain parts of the supply chain.
The global chip industry is complex and rapidly evolving. When it comes to semiconductor investing, understanding the industry’s nuances is only part of the success equation. Identifying compelling long-term investments requires intellectual curiosity and an open mind. Rigid, dogmatic thinking is usually not a recipe for success in any domain—semiconductors or elsewhere.
Greg Scolaro, CFA, is a research analyst on William Blair’s global equity team.
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 Source: Bloomberg, as of 5/10/23. Shows annualized total return since 5/10/13. Refers to the Semiconductors & Semiconductor Equipment category of the MSCI All Country World Index (ACWI) Investable Market Index (IMI). Index performance is provided for illustrative purposes only. A direct investment in an unmanaged index is not possible. Past performance is not indicative of future returns.
 Ending 3/31/23