NVIDIA (NVDA), Broadcom (AVGO), and other chip stocks might face some challenges in the short term, however, cloud computing, the automotive industry, and complexity continue to back a bullish view, BofA Securities said in a note Monday.
Analysts, including Vivek Arya, said that the SOX index has gone up 23% this year, with semiconductor companies now being among the biggest in the S&P 500 index. Previously, chip stocks and the broader market or SPX had similar price-to-earnings ratios, but since November 2022, the SOX index has been trading at a higher premium.
In the short term, however, the SOX might face some challenges due to factors like increasing interest rates, US elections, geopolitical tensions, negative news about artificial intelligence, and seasonal weakness in Q3, the analysts added.
The top five global semiconductor equipment stocks are currently trading at a 46% premium versus their historical average, with a price-to-earnings ratio of 26 times their expected earnings for 2025, compared to the historical average of 18 times, the analysts said.
They added that they anticipate this premium to continue due to factors like increased complexity in AI-driven chips, efforts to bring manufacturing back to home countries, and the stocks’ strong free cash flow margins, which have remained above 25% even during the recent downturn in the semiconductor industry.
“Industrial/auto chip stocks are less crowded and offer diversification away from AI, with easier compares going into 2025. End of inventory correction could support solid double sales growth into 2025. However, analog stocks are currently trading at stretched valuations discounting a strong, but still uncertain macro recovery,” the analysts said.
BofA Securities raised its price target on NVIDIA to $1,500 from $1,320 while keeping its buy rating. The analysts said that the change is based on a price-to-earnings ratio of 42 times expected earnings for 2025, excluding cash. This valuation is justified because of the promising growth prospects ahead, especially as the gaming cycle bottoms out and there’s potential for robust, long-term demand in the data center sector, the analysts added.