SMH: Taking Advantage Of Expected Global Semiconductor Growth In 2024

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Investment Thesis

VanEck Semiconductor ETF (NASDAQ:SMH) warrants a strong buy rating to take advantage of expected semiconductor growth through 2040, its strong performance in comparison to peer ETFs, and relatively low expense ratio. While 2021-2022 saw a dip in the semiconductor industry, supply chain stabilization is driving the industry towards a strong 2024. Although the fund is heavy on Nvidia Corporation (NVDA), the ETF is diversified with several other strong holdings.

Fund Overview and Compared ETFs

SMH is an ETF that seeks to track the performance of the MVIS US Listed Semiconductor 25 Index, or MVSMHTR. With its inception in 2011, the fund has 26 holdings and $11.72B in AUM. SMH is 100% focused on large cap, information technology sector stocks. In particular, as its name implies, its holdings are focused on the semiconductor industry.

For comparison purposes, other ETFs examined are Invesco’s Semiconductors ETF (PSI), SPDR S&P Semiconductor ETF (XSD), and iShares Semiconductor ETF (SOXX). PSI is based on the Dynamic Semiconductor Intellidex Index and therefore includes some mid and small cap holdings with much lower weight on NVDA. XSD seeks to track the S&P Semiconductor Select Industry Index. XSD is the most diversified ETF examined with 39 holdings. SOXX generically seeks to track the returns for U.S. listed equities in the semiconductor sector. This is a key difference with SMH which has international holdings including 12.75% in the Taiwan region and 8.02% in the Netherlands.

Semiconductor Growth and Market

In the wake of the COVID pandemic, demand for cars and many other products that required semiconductors declined. This resulted in an increase in supply and built-up inventories. This oversupply negatively impacted the semiconductor industry in 2021 and 2022. Subsequently, share prices for many semiconductor companies dropped in late 2022. NVDA, for example, saw a share price decline from $294 at beginning of 2022 to $146 at end of 2022.

However, 2023 witnessed the start of an expected long-term turnaround. Supply issues have evened out and the semiconductor industry is now expected to see a 12.3% CAGR through 2030. While most of the global semiconductor supply comes from Asia, the U.S. produced approximately 12% in 2021.

Global Semiconductor Revenue Forecast (www.gartner.com)

As a result of this rebound, semiconductor companies saw strong returns this past year. NVDA, for example, was up over 230%. Broadcom, Inc. (AVGO), another popular semiconductor company, was up over 100% in the past year. Global revenue demand is expected to increase through 2024 and beyond. For investors looking to take advantage of these returns, SMH offers an opportunity to take advantage of expected semiconductor profits.

Performance, Expense Ratio, and Dividend Yield

SMH has seen an impressive 10-year CAGR of 24.36%, far surpassing the S&P 500 index 10-year CAGR of close to 12%. In comparison to other semiconductor ETFs examined, SMH has seen superior performance, higher than PSI (10-year CAGR of 23.43%), XSD (10-year CAGR of 21.90%), and SOXX (10-year CAGR of 23.16%). SMH also ties for the lowest expense ratio of ETFs examined at 0.35%.

5-Year Total Price Return for SMH and Peer Semiconductor ETFs (Seeking Alpha)

Not surprisingly, dividend yields for all semiconductor ETFs are relatively low. The companies contained in the ETFs as holdings reinvest their profits to continue growing versus disbursing their earnings in the form of dividend payouts. Despite a low dividend yield, SMH has a 5-year dividend growth CAGR of 11.55%.

Expense Ratio, AUM, and Dividend Yield Comparison

	SMH	PSI	XSD	SOXX
Expense Ratio	0.35%	0.57%	0.35%	0.35%
AUM	$11.72B	$682.35M	$1.49B	$10.28B
Dividend Yield TTM	0.60%	0.40%	0.32%	0.96%
Dividend Growth 5 YR CAGR	11.55%	40.34%	-1.36%	15.97%

Source: Seeking Alpha, 31 Dec 23

SMH Holdings and Its Competitive Advantage

SMH has the fewest holdings of semiconductor ETFs examined. It therefore is highly concentrated on its top holdings, particularly NVDA, at over 19% weight. SMH is also the most internationally diversified fund compared to peer ETFs. This represents geopolitical risk on top of an industry that is already relatively volatile. However, I will cover more on that later.

Top 10 Holdings for SMH and others (Key Differences Bolded)

SMH – 26 holdings	PSI – 31 holdings	XSD – 39 holdings	SOXX – 30 holdings
NVDA – 19.39%	AMD – 5.42%	MXL – 3.03%	AMD – 8.65%
TSM – 9.06%	INTC – 5.02%	FSLR – 2.97%	AVGO – 8.57%
AVGO – 6.08%	AVGO – 5.01%	AVGO – 2.96%	NVDA – 7.53%
AMD – 5.67%	QCOM – 4.99%	INTC – 2.94%	INTC – 6.42%
INTC – 5.44%	LRCX – 4.87%	MRVL – 2.89%	QCOM – 6.40%
ASML – 4.88%	MU – 4.85%	AMD – 2.87%	NXPI – 4.00%
LRCX – 4.56%	AMAT – 4.75%	LSCC – 2.86%	MU – 3.99%
AMAT – 4.52%	NVDA – 4.39%	ALGM – 2.86%	TXN – 3.97%
QCOM – 4.50%	PLAB – 3.52%	WOLF – 2.85%	ON – 3.93%
ADI – 4.45%	MKSI – 3.24%	MU – 2.85%	LRCX – 3.89%

Source: Multiple, compiled by author on 31 Dec 23

All ETF investors know that the future return of the fund is tied to the performance of its individual holdings. I believe SMH has multiple key advantages seen with its holdings including its high weight on NVDA and its inclusion of foreign companies. These foreign holdings include Taiwan Semiconductor Manufacturing Company Limited (TSM) and ASML Holding N.V. (ASML). I will dive deeper into each of these further below.

Heaviest Weight of NVDA

The first difference separating SMH from its peer competitors is its heaviest weight on NVDA. While the company saw a 73% share price return in 2023, it shows several signs of continued growth into 2024. The company ambitiously looks to triple its AI production and is expanding globally. In 2023, Nvidia announced a partnership with Vietnam and Malaysia to increase its global production and infrastructure. Having already seen a 57% YoY revenue growth and 154% YoY EBITDA growth, NVDA is primed for continued acceleration heading into 2024.

SMH’s Inclusion of TSM

The second difference is SMH’s inclusion of TSM as its #2 holding. At 9% weight, TSM is heaviest with SMH among all compared semiconductor ETFs. This cutting-edge company produced 3-nanometer chips before Intel Corporation and is leading competition with 1.4nm chips. TSM has proven itself incredibly profitable with a 57% gross profit margin and 41% net income margin. It also is still favorably valued with the company’s forward P/E GAAP at 28% below its sector median.

ASML in Top 10 Holdings

The third key ingredient separating SMH from its competitors is Dutch semiconductor equipment company, ASML, a top 10 holding at 4.88% weight. The company makes lithography systems that use lasers to create the chip circuitry for semiconductors. ASML is another highly profitable company with a 28% net income margin and 38% return on total capital. ASML is seeking to achieve upwards of $35B in revenue along with a gross margin up to 55% by 2025.

Valuation and Risks to Investors

SMH is currently trading at $174.87 at the time of writing this article. This is just below the upper limit of its 52-week range and all-time high of $176.75. Similar to its 10-year return, SMH has also outperformed its peer competitors over the past year. For 2023, SMH returned over 70%, notably higher than SOXX (65%), PSI (48%), and XSD (34%). SMH also significantly outperformed the S&P 500 index in 2023.

2023 Total Price Return: SMH and Peer Competitor ETFs (Seeking Alpha)

Despite this strong performance historically and more recently in 2023, SMH is valued roughly on par with its peers. With a P/E ratio of 28.31, SMH’s price-to-earnings ratio is lower than XSD and SOXX. Given SMH’s reasonably comparative valuation metrics and strong expected growth for the semiconductor industry into 2024, one can reasonably expect the fund to perform at least as strong as its historic CAGR.

Valuation Metrics for SMH and Peer Competitors

	SMH	PSI	XSD	SOXX
P/E ratio	28.31	23.16	29.95	28.33
P/B ratio	6.06	3.73	4.26	5.41

Source: Compiled by Author from Multiple Sources, 31 Dec 23

Although SMH is expected to see solid returns, semiconductor ETFs have a fair amount of risk. Despite being the most concentrated around its top holdings, SMH’s 3-year beta value remains on par with its peers. Compared to the S&P 500 index, SMH’s beta is 1.45. This is higher than PSI’s 60-month beta (1.39) and SOXX’s 60-month beta (1.34), indicating higher volatility than “the market” overall and slightly higher than its peer competitors.

Beyond market volatility, SMH is subject to geopolitical risk. Although 76.20% of SMH’s holdings weight is in U.S. stocks, it also includes 12.75% in the Taiwan region, and 8.02% in the Netherlands. While there are no impending indications of conflict in the South China Sea region, its continuous possibility casts a shadow on the geopolitical risk for TSM and the semiconductor industry at large.

Concluding Summary

While the semiconductor industry saw a decline in the 2021-2022 timeframe, 2023 saw the start of a long-term turnaround. Multiple indications point towards strong growth and profitability for the industry in 2024 and beyond. Investors looking for diversification with several key semiconductor holdings may be able to achieve their goals with SMH. The fund has historically outperformed peer semiconductor ETFs and has a relatively low expense ratio. While SMH is heavy on NVDA, the fund includes other strong holdings such as TSM and ASML.

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