slow
The cyclopean rise and reach of big technology seems unstoppable.
The tech sector holds a larger percentage of the U.S. market capitalization than any other sector has ever had, and it’s not even close. While the software side of the sector appears well isolated Longer term, the semi-finals show several “warning signs”, according to a UBS report.
One signal is the extreme dynamics of the prices of semi-finished products, which means that they are overbought.
“On a six- to 12-month basis this was a warning sign,” UBS analyst Andrew Garthwaite and others said. “This comes at a time when, as we have warned recently, price momentum as a style is vulnerable.”
However, simply removing Nvidia (NVDA) and Advanced Micro Devices (AMD) from the formula significantly reduces overall price momentum, UBS notes.
Another warning sign in the semi-finished products sector is overvaluation as, according to UBS data, the price/income ratio compared to the market is at record levels.
Semi-finished products are also much more exposed to geopolitical risks as 20% of the sector’s revenues come from China.
Earlier this week, China said it wanted to ban purchases of Intel (INTC) and AMD chips for government use. On a nominal basis, Intel had about 27% of its sales in China in 2023, or $15 billion, while AMD had 15%, or $3.4 billion. Public purchases accounted for approximately 10%.
In comparison, Microsoft (NASDAQ:MSFT), the largest player in the software industry, has less than 2% of its revenue tied to sales in China, UBS notes.
UBS also noted the decoupling of semis from earnings revisions.
“Earnings revisions were very strong, but there was a strong decoupling with performance,” UBS said. “Even if we exclude Gen-AI companies, we can see reasonable decoupling. This is a warning that valuations are getting expensive.”
Meanwhile, software stocks are neither overbought nor overvalued. There also appears to be more room for software companies to expand the total addressable market. Labor shortage issues are also a boon for software sales.
“We can see from data from the National Federation of Independent Businesses that there is still a labor shortage, and normally this is associated with higher spending on software, implying that a higher TAM number may be appropriate,” notes UBS .
Microsoft’s advantage
The current market advantages for software companies are particularly helpful for Microsoft, which is why UBS sees this as a “critical long run.”
Furthermore, with such a large current user base, Microsoft has the ability to regularly increase prices since the software represents such a low percentage of total business or home costs.
With the integration of generative AI, CoPilot’s pricing strategy seems much clearer than competitors’ attempts to monetize AI, UBS notes.
Nvidia in a league of its own
Despite some warning signs, the semiconductor sector remains in excellent shape. It is the fastest growing sector in terms of earnings per share and UBS still gives it a top position in the quality ranking.
There is also no overinvestment in the sector, meaning capital expenditures for sales and capital expenditures for depreciation are not stretched, UBS said. Additionally, semis don’t have much debt, and many have remained debt-free in recent years.
Nvidia stands out as one of the strongest players in this sector. UBS called it “the only chip company capable of creating its own market.”
Maintains Buy rating and $1,100 price target.
Nvidia’s stock value has increased nearly 2,000% over the past five years and more than 80% year to date.
TSM increasing
Taiwan Semiconductor Manufacturing Company (TSM) is also well positioned for the future.
“TSMC is five years ahead of its Chinese rivals and two years ahead of its U.S. rivals,” USB said. “It controls the majority of cutting-edge foundry production and has the ecosystem to continue to be the No. 1 foundry supplier.”
The company expects 13% of its revenue to come from high-end AI chips by 2025.