Can Investors Profit From the Semiconductor Shortage?

Supply shortages in the semiconductor sector are weighing on many stocks, both inside and outside the chipmaking industry. It’s bad news for many stocks and their shareholders, but the unique situation also creates buying opportunities for semiconductor investors.

Here’s a quick rundown of the chip shortages, followed by a couple of strong investment ideas.

What’s going on?

The semiconductor industry relies on a brittle supply chain. Most chip designers don’t have manufacturing lines of their own, depending on a small handful of third-party foundries to turn their blueprints into physical products. The leading foundries, in turn, have optimized their chipmaking operations for supplying processors to the global electronics manufacturing hubs in China and Taiwan.

That’s normally a good strategy, but a combination of political pressure, natural disasters, and the COVID-19 pandemic triggered a massive supply-side shortage last year. The deficit lingers on today, shaking up the semiconductor industry itself and the many sectors that depend on a steady supply of chips.

The most obvious idea

Let’s start with the foundries. Market makers have already caught on to the idea that United Microelectronics (NYSE:UMC) and Taiwan Semiconductor Manufacturing (NYSE:TSM) will benefit from the supply shortage, as customers are stuffing their order pipeline completely full. As a result, United and TSMC have crushed the market over the last two years. These companies are great, but their stocks are fully valued today.

Smaller players in the chip-manufacturing sector have seen smaller price bumps. I’m particularly interested in Tower Semiconductor (NASDAQ:TSEM). The Israel-based company runs most of its chip-manufacturing business out of facilities in Japan, Israel, Texas, and California, which helps the company sidestep the political heat in Greater China.

Tower Semi’s stock is beating the Street over the last two years but by a far smaller margin than the big boys:

^SPX Chart

Tower Semi stands on the threshold of a potential golden age, given its unique ability to produce and deliver large volumes of chips that are as American as apple pie and baseball. Yet the stock trades at just 2.2 times trailing sales while United’s shares command a 3.4 price-to-sales ratio and Taiwan Semi is soaring at 11 times sales.

The company is also poised to ramp up its manufacturing activity right now. Some of its foundry facilities are running at close-to-full capacity, but others have plenty of headroom for additional orders.

According to CEO Russell Ellwanger in the recent first-quarter earnings call:

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