2 Little-Known Semiconductor Stocks to Buy for 2023
Chip stocks are down, but they’re far from right now. In fact, global chip sales are expected to go on an epic run over the next decade, driven by numerous secular growth trends ranging from cloud computing to artificial intelligence (AI) to electric vehicles. Various estimates suggest that semiconductors will go from roughly a $600 billion industry to more than $1 trillion in 2022 by the end of the decade.
However, it will be a bumpy ride as chip sales are cyclical. In fact, a down cycle is currently in effect. But two little-known, yet critical companies to the semiconductor industry — Overview (SNPS 1.64%) and Cadence design systems (CDNS 0.60%) — can be fantastic investments down the road. Here’s why these two software plays on the PC hardware space are key stocks to consider for 2023.
The next wave of computing innovation is happening now
To push computer performance to new heights, chip designers are adopting new ways to package semiconductor systems — such as chips, multiple smaller chips assembled into a larger integrated circuit. Some chip designers like Intel think several suppliers will be involved in providing the parts for a chiplet computer architecture model.
Other innovations include embedding software into chips early in the design process. Software technologies also help accelerate development times with features such as molecular-level simulation of chips, AI tools to solve design problems, and the use of pre-designed adaptive circuits to speed overall design.
All of this requires a complex suite of software to coordinate all the various engineering teams and stakeholders involved in the design of modern computing systems. This is where Synopsys and Cadence come in. There is a lot of overlap between what these two software companies do, but together – with Mentor, which is now owned by the German industrial conglomerate Siemens — they are a critical part of the chip industry known as electronic design automation (EDA) software. Whether a semiconductor designer, a chip manufacturer, a computer system assembler, or a software engineer, there is a good chance that Synopsys or Cadence is an important part of the software suite in use.
And because Synopsys and Cadence are mostly subscription-based models, they put up consistent growth numbers. This stands in stark contrast to many other chip companies that ebb and flow with the economy or cycles of semiconductor sales booms and busts.
Data by YCharts.
The result is some differentiated share price performance. Because of their agreements, Synopsys and Cadence shares trade in close step with each other, but both handily beat the market in 2022.
Put these two stocks on your watch list
Because of their premium valuations, I have held off on buying either Synopsys or Cadence Design. But as 2023 approaches and the next wave of computing technology begins to be commercialized, I’m ready to start buying. I will use a dollar-cost averaging method, which will likely add to one or both stocks on a monthly basis early next year.
The premium price tags for both (Synopsys trades for 32 times trailing 12-month free cash flow, Cadence for 42) seem well-deserved. Both companies are growing at a steady rate, are highly profitable, have excellent balance sheets and are buying back stock.
Metrics | Overview | Cadence design systems |
|---|---|---|
Most recent quarter’s revenue growth | 11.5% | 20% |
Next-12-month operating profit margin | 23.1% | 30.8% |
Next-12-month free cash flow profit margin | 31.5% | 31.7% |
Next-12-month stock buyback | $862 million | $865 million |
Total cash and short-term investments | $1.57 billion | $1.09 billion |
Total debt | $20.8 million | $798 million |
Data sources: Synopsys and Cadence Design Systems.
One note to keep in mind: Cadence recently acquired molecular modeling and simulation software company OpenEye Scientific, which it also took on new debt to buy. Synopsys also grew sales by 21% during its recent 2022 fiscal year, so the growth profiles for the two companies are much closer than the most recent quarter would indicate.
But make no mistake, a decade of new computer technology advancements is poised and ready to go. Synopsys and Cadence Design will play a pivotal role in their development and commercialization. As such, I think these two stocks should be staples for semiconductor investors in 2023.
Nicholas Rossolillo and his clients have no position in any of the listed stocks. The Motley Fool has positions in and recommends Cadence Design Systems, Intel and Synopsys. The Motley Fool recommends the following options: long January 2023 $57.50 calls on Intel, long January 2025 $45 calls on Intel, and short January 2025 $45 puts on Intel. The Motley Fool has a disclosure policy.
