Here’s Why Semiconductors May Actually Be Undervalued

With valuations soaring to historical records, the semiconductor industry is making some investors nervous — but its rally could still actually only be in the early innings.

As Bloomberg notes, the sector has enjoyed massive growth over the past year:

The Philadelphia Semiconductor Index, composed of 30 chip-related companies, has gained 47 percent since last April, fueled by an unprecedented flood of mergers and orders for products that make up the guts of gadgets like refrigerators to smartphones. That’s made the $300 billion industry look expensive relative to earnings as growth is expected to moderate.

That rally has pushed the price-earnings ratio for the semiconductor index to 28, versus its seven-year average around 22. The S&P 500’s price-to-earnings also sits around 22, making chip stocks not only expensive versus their historical norms, but also versus the wider market as well.

But with so much consolidation in the industry, and earnings rising quickly to catch up with stock prices, is there anything to worry about?

Analysts are largely split on that question. Some believe that old valuation metrics no longer apply, while others are concerned that the M&A momentum is mostly over with, which could mean a major cap to additional upside.

Only time will tell, but there’s one thing everyone can agree on: semiconductors are being integrated into more and more devices every single day, and that trend will not abate any time soon.

On the ETF side of the industry, the iShares S&P NA Tech Semiconductor Index Fund ETF (NASDAQ:SOXX) was unchanged in premarket trading Monday. Year-to-date, SOXX has gained 10.16%, versus a 5.22% rise in the benchmark S&P 500 index during the same period.

SOXX currently has an ETF Daily News SMART Grade of A (Strong Buy), and is ranked #11 of 54 ETFs in the Technology Equities ETFs category.

Meanwhile, the other major semi ETF, the VanEck Vectors Semiconductor ETF (NYSE:SMH) was unchanged in premarket trading Monday. Year-to-date, SMH has gained 10.44%.

SMH currently has an ETF Daily News SMART Grade of A (Strong Buy), and is ranked #15 of 54 ETFs in the Technology Equities ETFs category.

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