2 Top Small Cap Semiconductor Stocks For 2024 and Beyond?
At this point it is a high valuation, this is a small business with a very, very large peers, and there's always that risk that you get steamrolled by some of your more, better financially endowed peers. But at this juncture, this looks like a great value stock to us. Again, long term track record, earnings growth, producing a little bit of a dividend and stock buybacks over time.
Hey everyone. Welcome back to another week at Chip Stock Investor. We have lots of good things planned for the channel and our Discord community this week.
We have our cybersecurity manual for 2024 coming out later this week, as well as a video that outlines the cybersecurity industry. We've been working on those things for several months now, and we are excited to announce that we'll have both of those out later this week. Of course, we also have Salesforce reporting tomorrow, and then we have Broadcom next week.
So we still have some earnings to roll through and we will get those out to you as soon as we can. But before we tackle those items, we wanted to talk about two small cap companies that we really like in the semiconductor space. Actually the first one, Kasey, one of our favorite, and one of our top chip stock picks for 2024, if you remember just a couple months ago, back in December, =Silicon Motion, ticker symbol, S I M O let's do an update from their earnings report, which was quite good, actually, a few weeks ago, but really just got buried in the avalanche of earnings season and AI hype. You may remember Silicon Motion was part of the acquisition merger with Max Linear just last year that fell through. And so now Silicon Motion is all on its own, and that's actually one of the reasons why we like Silicon Motion. Silicon Motion is a small semiconductor designer of memory controllers, and that's a type of application specific logic chip that governs the flow of data into and out of memory in devices like PCs, smartphones, and autos.
Silicon Motion has also been expanding into enterprise applications too for servers and data centers. And this company is actually the market leader in this type of chips. Yeah. And specifically the memory controllers we're talking about here are SSDs or solid state drive controllers in like PCs, EMMC, embedded multimedia controllers and UFS, ultra flash storage controllers that you'll find in smartphones and we'll touch on this briefly, but we'll just show it right here, Kasey, this is sort of an ancillary bet on Synopsys. Maybe companies like Synopsys and Cadence Design Systems, the oligopoly that controls the electronic design automation part of the semiconductor industry.
Synopsys has quite a bit of IP in this department, especially in cryptography and security, that helps with the hardware level security of these devices, so that there's no intrusion into your device. Intrusion from those that aren't supposed to have access to what's stored on your device. So a couple of pictures here of what that looks like from Synopsys. we'll leave the link, below with their explanation of how these memory controllers aren't just used for high performance memory, interacting with the rest of the compute system of a consumer electronic device, but also with the security level as well.
At any rate, Kasey, Silicon Motion, the high performance leader in these SSD controllers, they have quite a bit of competition, which we should probably just acknowledge right off the bat. Even from some of its very own customers, when you think of companies like Micron or Samsung, which design leading edge memory chips, they also design some of these memory controllers to help control their own costs. Despite the competition that Silicon Motion has, their edge in the market is designing high performance chips.
So that ultimate device manufacturers and their memory chip suppliers select Silicon Motion over the prepackaged lower performance memory controllers that may lack that extra zest. Yeah, it's still worth calling out though. Again, Micron, Samsung, SK Hynix, and others. We covered this in our video that we did a number of months ago at the end of 2023 discussing this, you'll notice this is a risk across most small cap stocks. Some investors maybe don't want to acknowledge that, that's just life for a small cap business. You could get steamrolled by the competition.
So just keep that in mind. And also, Silicon Motion has been expanding into the data center arena as well, where they're going to bump up against leaders like Broadcom and Marvell Technology Group, the leaders in the enterprise department. but Silicon Motion has been doing pretty good.
This company has a pretty solid track record of generating growth. And it looks like now that the PC and smartphone market have stabilized, which is Silicon Motion's bread and butter, the company is expecting a new growth cycle starting in 2024. Yeah, it seems that PC and smartphone sales are stabilizing, but we haven't reached that all out growth cycle yet.
But they do expect to outpace the growth of the consumer electronics market overall in 2024, they're forecasting a 20 to 25 percent full year revenue expansion over the results of 2023. Nick, why don't you tell us why we're interested in this small cap stock, Silicon Motion? Well, the Max Linear acquisition that you mentioned fell through, last year is what initially put this on our radar in 2022. And then we made our first purchase in late 2022. And the acquisition was just a bonus if it happened great. But what we really liked about this business was again, the longterm track record of profitable growth, despite cyclicality inherent in this business, because again, PCs and smartphones. Not exactly a secular growth market anymore, but the company is still, picking up market share over the years because of its high performance memory controllers, lots of cash and reserves $314 million in cash and short term investments, $50 million in deposits and $17 million in long term investments.
Zero debt at the end of 2023. Now you probably look at this thing though and say, well, on a trailing 12 month basis, the valuation looks atrocious, totally out of whack. 44 times trailing 12 month earnings, but on a forward looking basis, shares trade for 20 to 21 times expected 2024 earnings and about 15 times 2025 expected earnings, which, you know, that's too far for us to forecast with any certainty, but that's the consensus from wall street analysts.
So let's maybe back up though to those 2024 expectations. Which management did provide us some guidance on. The revenue is expected to grow 20 to 25 percent year over year to $765 to $800 million in revenue.
GAAP, operating margin guidance is 10.4% to 12.8%. It was 6.2% in 2023. That implies operating income range of $79.6 million to $102 million.
The current enterprise value, of Silicon Motion is $2 billion, and currently, at the high end of outlook stock trades for 20 times enterprise value to 2024 operating income. Yeah. And to us, I would say this is fairly conservative guidance for Silicon Motion. They actually talked about some of their top customers utilizing ample amounts of their new memory controllers this year. They're actually expecting from these core customers, about 50 percent revenue growth this year. So management could be under promising and over delivering.
Of course, they are in litigation right now with MaxLinear. If they get some sort of cash award, for MaxLinear pulling the rug on that acquisition, that would be again, just a nice added bonus. But at this juncture, this looks like a great value stock to us. Again, long term track record, earnings growth, producing a little bit of a dividend and stock buybacks over time. So what we did was we actually swapped out our position in Micron and replaced it with a few smaller bets.
One on Pure Storage. Of course, we have Synopsys already and then Silicon Motion. This is one that we're more than happy to hold at this point. It looks like the company is entering a new spat of growth. And.
The valuation looks very attractive for this business. So this is a really good small cap stock that we feel pretty good about, but you know, do your own due diligence and can't emphasize enough, all small cap stocks have big competitors. Most small cap stocks don't have a real moat. Some people would argue that, but it's just facts. If you're a small business with big competition, your biggest competitive advantage is actually playing technological offense.
That's what Silicon Motion is doing. So it's going to be a lumpy stock price, but we like it. Let's move on to our second small cap stock, Onto Innovation.
This company we've talked about a couple times in our videos. It falls into the semiconductor wafer manufacturing equipment section of the flowchart. They specifically provide equipment for the process diagnostic control portion of the semiconductor industry. You can take a look at our chart that we are borrowing from Applied Materials. You can see the blue portion at the bottom there, that's Applied Materials, KLA has the biggest share in this section of the industry and then that gray section is where Onto fits in. They make equipment that tests wafers and chips or system on chips for defects.
And this helps a company with their research and development and maximizes the production quality and yield of the wafers. Onto also has some competition in that small space in the gray area. They have competition with Camtek as well as Nova, both based in Israel. Yeah, for sure. Metrology was a hot sub segment of the semiconductor wafer fab equipment space. And again, Kasey, yes, I think we do need to categorize this as a small or mid cap, even though the enterprise value is now over $8 billion after this most recent run up.
And we categorize it as such because of that big dominant competitor KLA Corp, as well as Applied Materials. When you have an enterprise value of $8 billion, I don't know, times have changed, small caps being, pegged at under $2 billion, it just seems a little bit outdated to us, here in 2024, but at any rate, we'll digress or I'll digress, from that soapbox. What happened in 2023, that sent the stock rocketing higher once again. Maybe to illustrate that point, Nick, let's take a look at this chart from our friends over at Mainstreet Data.
You can see that there was a growth cycle there in 2022 where the company reached peak revenue and then a fall off at the very beginning of Q1, 2023. Looking at that last bar Q3, 2023, you can start to see the beginnings of a growth cycle and actually for the numbers for this fourth quarter, they reached a revenue of $219 million, which was 5. 8 percent quarter over quarter increase, still down 13 percent year over year, but they're expecting an 11.
5 percent increase year over year next quarter in the outlook, revenue to be $215 to $230 million. Notice this comment that CEO Michael Plisinski said on their Q1 outlook. He said their guidance range for the first quarter reflects continued strong demand for the Dragonfly inspection systems to support increases in AI device production.
They expect business in the first quarter to be three times larger than in Q1 of last year before the generative AI and large language model started to hit the market. So broadly speaking, they see advanced packaging, especially for leading edge AI devices will be a healthy multi year driver for the business. Yeah.
And this is why the stock trades for a seemingly absurd valuation. We'll get to that in a moment, Kasey, but everybody knows the buzzwords surrounding AI, or accelerated computing. Everyone wants to talk about chiplets, heterogeneous integration, basically the same thing, using various, semiconductor technologies and packaging them together, for tighter performance between these different disparate types of chips.
Advanced packaging, We already discussed this with Applied Materials a couple of weeks ago. This is one of the key pillars supporting semiconductor advancement in the five to 10 years ahead and what is helping propel things like accelerated computing higher. Onto Innovation, very much a picks and shovels play, if you want exposure to this whole thing. It is very much part of the foundation of the current bull market that has now begun, I think without much argument from many people at this point, the bull markets here, Onto Innovation, most definitely participating.
And more than just the revenue outlook for the next quarter Kasey, actually in Q4 with revenue still down year over year from their peaks, the company was actually hitting fresh all time operating margin highs, wasn't it? You can see in their Q4 highlights, they had record quarterly cash from operations at 62 million, which is 28 percent of revenue. And then another key metric here, Nick, is the balance sheet for Onto Innovation. Cash and short term investments of $698 million, which is an increase of $150 million from the beginning of the year. And Onto Innovation is actually a result of a merger back in 2019, and it's an acquisitive business. They're looking for more purchases to accrue market share and with no debt on the balance sheet and a growing cash balance, we could see that happening in the future. Absolutely.
And it makes sense because the semiconductor manufacturing industry is highly collaborative. One of their key customers is of course, Taiwan Semiconductor Manufacturing, TSMC. So as companies like TSMC, like Intel, like Samsung ramp up their next gen chip making capabilities, whatever it is, it could be new so called two nanometer, transistor technology, this transition to gate all around chiplets, advanced packaging, you name it, you need metrology, this process diagnostic and control equipment and some of the other stuff that Onto makes, to help with the research and development before you roll out widespread production for your chip design customers. So Onto a very, very key part of this ecosystem as lots of companies start designing new chips in support of all sorts of stuff.
Let's call it AI, accelerated compute, but there's a lot going on here and you need the metrology equipment. It's a key ingredient to all of it. And one more thing here, Kasey, that we that we might mention before we go into the specific valuation notes that we have, so all of these buzzwords across the semiconductor industry, propping up the valuation to a very, very high mark, but we'll put a link here to the video that we did last August after Onto's last investor day presentation. We were told to look for $1.
5 to $2 billion in revenue within the next few years. Significant growth for a company in the wafer fab equipment and packaging parts of the semiconductor industry. But based on some of these comments, it looks like maybe we need to revise our estimates up a bit. It looks like we could see this business hit $2 billion in revenue pretty quickly here within the next three years or so, based on some of the guidance hints that they're giving shareholders at this point. Let's talk about valuation for Onto Innovation. Based on the stock price of around $181 on February 27th, 2024, it seems like it's trading at an absurd rate, at 80 times trailing 12 months earnings per share.
Tell me a little bit more about that, Nick. is that as absurd as it sounds? It's high. It is.
It's very high for an equipment maker. It's a cyclical business. Equipment is always going to be cyclical. again, we've already covered this with Applied Materials with Axcelis most of the fab five, even ASML Holding, not going to escape some of the cycles inherent in manufacturing, because that is exactly what semiconductors are. This is the manufacturing and infrastructure layer of the digital economy. So 80 times earnings is high, but if you look at the 2024 expectations, which right now are penciled in at about $3 and 60 cents for GAAP earnings per share, roughly $222 million in free cashflow, which would put it at roughly a 20 to 25 percent free cashflow margin for the year.
The company trades for 50 times expected earnings. 36 times expected free cashflow. So it's maybe not as absurdly high as it appears on the surface, this is still a high valuation to be perfectly clear.
The market is again, probably predicting some outperformance on revenue and profit margins through 2025, 2026 for this current upcycle for the equipment space. Another factor that plays into it is that they're factoring in possible acquisitions of other companies for Onto Innovation to eat up some market share. And that is also playing into that high valuation. So what are we doing with our stock, Nick? Yeah, we bought initially almost a year ago in March, 2023.
So we're happy where we're at with Onto, we bought a couple of different times last year, and so we're not trimming. This is a small cap stock. It's part of our small cap basket, which includes Silicon Motion. So we're keeping that basket well diversified and letting these things do their thing. We might consider adding to this one if there's a pullback in the stock, let's say maybe 10 percent or more pullback, before we consider adding more. But at this point it is a high valuation, and again, much like Silicon Motion, this is a small business with a very, very large peers, and there's always that risk that you get steamrolled by some of your more, better financially endowed peers.
This is a really, really great company that has been executing very well for the last four or five years since their merger that created the business we now know as Onto Innovation. So keep this one on your radar. We'll be talking about it again, I think later this year.
I'm pretty sure about that. I think so too. That's a wrap for these two small cap companies Onto Innovation and Silicon Motion. If you've not done it already, make sure you hit subscribe and have notifications turned on. And of course, if you're interested in our show notes and manuals, please check our Ko fi page under the shop section, or you can always join our channels membership over on Ko fi or here on YouTube.
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2024-03-05 04:54
