How to Invest in Semiconductors

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Semiconductor stocks have had a great year with the industry up double digits so far in 2017. With billions of devices expected to be put into use in the years ahead, growth for chip makers could continue. Here's what investors need to know.

Old tech that's pushing the envelope

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Since their invention midway through the last century, microchips have been at the heart of technological growth. Today, the small devices are the building blocks for almost everything electrical. While historically associated with computers, semiconductors are also a part of leading technology like artificial intelligence, self-driving vehicles, and robotics.

Advances in semiconductor tech have led to them being an integral part of virtually every other industry as well, from computing and communications to healthcare and manufacturing. According to a report from Semiconductor Industry Association, an industry research and promotion group in the U.S., semiconductors have been by far the fastest growing manufacturing segment since 1987.

That growth is expected to continue, with technology research company Gartner (NYSE: IT) saying that industry revenues will increase 12% in 2017. Those trends are anticipated to have momentum into 2018, and global demand is only expected to climb over the long term. With the U.S. being the leading producer of microchips, the industry should be a part of any long-term investor's portfolio.

An easy place to start

Selecting an investment in a chipmaker can be difficult as there are dozens of manufacturers and related support companies in the U.S. For those who don't want to do the homework, there are a few ETFs that offer broad exposure to the whole U.S. industry.

Which ETF is right for you? You'll notice that over time, all three have pretty similar performance. The iShares and VanEck funds especially have a lot of overlap in their portfolio holdings. Favoring larger companies, both of those funds should have smaller swings up and down than the SPDR fund. SPDR's heavier inclusion of smaller companies can give the fund more upside in a bull market, but also more downside if the industry takes a turn for the worse.

Whittling down the playing field

For those who want to hand pick individual stocks, semiconductor companies can be broken down into several categories: broad line, integrated circuits, specialized, equipment & materials, and memory chips.

Some of the biggest and most recognized names are broad line chipmakers, those that produce semis for a wide range of industry and final use. Names include the world's largest chipmaker Intel (NASDAQ: INTC), as well as smaller players like Advanced Micro Devices (NASDAQ: AMD), Cypress Semiconductor (NASDAQ: CY), and ON Semiconductor (NASDAQ: ON).

The other categories are an array of manufacturers that either focus on a particular type of chip (like memory) or a particular process in the production of chips. Here are a few to start doing some research on.

Some caution is needed

For investors looking to minimize volatility, broad line semiconductor companies are a good start. These manufacturers are diversified and often pay out the highest dividends in the industry. The other sub-industries can be a bit more up-and-down as the companies are less diversified, but the trade-off is they could offer some of the biggest growth potential over the long-term.

Some caution on semi stocks, though, is that they are cyclical in nature. That means the industry can have periods where supply and demand swings wildly, causing share prices to be quite the roller coaster ride. For example, Gartner sees supply outpacing demand for memory chips in 2019, which has the potential to send stocks in that realm south.

However, the semiconductor industry is still growing and is at the forefront of technological innovation. Whichever route you go, these stocks have the potential to pay off big with some patience and diversification across at least a few of them.

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Nicholas Rossolillo owns shares of Ambarella, Cypress Semiconductor, On Semiconductor, and Skyworks Solutions. The Motley Fool owns shares of and recommends Gartner, Nvidia, and Skyworks Solutions. The Motley Fool has the following options: short November 2017 $95 calls on Skyworks Solutions and short November 2017 $92 puts on Skyworks Solutions. The Motley Fool recommends Cypress Semiconductor and Intel. The Motley Fool has a disclosure policy.