The arms race in artificial intelligence (AI) is creating a favorable demand environment for leading semiconductor companies. The PHLX Semiconductor Sector index has soared 122% since bottoming out in 2022, far outpacing the 69% return of the tech-centric Nasdaq Composite.
While the chip industry experiences occasional dips in revenue, the sector has been on a steady upward trajectory since the 1980s. The growing demand for high-performance chips to support the AI server build-out should create many years of strong growth for the leading suppliers.
Here are two top semiconductor stocks with superior return potential over the next decade.
1. Arm Holdings
Arm Holdings (ARM 1.34%) might not be as familiar to some as Intel, but it is one of the leaders of the semiconductor industry. It licenses designs for central processing units (CPUs) that are used in Arm-based Windows PCs, smartphones, supercomputers, and cloud servers.
Because it generates revenue from licensing and royalties, it is a very profitable business that can deliver superior shareholder returns.
Arm is currently seeing strong adoption for its Armv9 technology due to its better performance and energy efficiency. Its expertise in designing low-cost and efficient chip technology will be beneficial for energy-hungry data centers.
Royalty revenue surged 37% year over year last quarter, indicating market share gains in the cloud computing market. All the leading cloud providers, including Alphabet's Google, Amazon, and Microsoft, are using Arm-based chips. Its integration with Nvidia's Grace CPU positions Arm as a leading supplier of AI applications in data centers.
Another growth opportunity is AI-enabled PCs. Arm-based chips are the standard used in 99% of the world's smartphones, and it could see similar gains as the PC market moves away from the traditional x86 processors from Intel to Arm-based chips.
The biggest risk for Arm investors is the stock's high valuation, which looks expensive at a forward price-to-earnings ratio of 100 based on this year's consensus earnings estimate. It's still worth pulling the trigger because Arm is becoming the gold standard of CPU technology across all the most important computing markets.
Its lucrative business model based on licensing and royalty revenue should support robust earnings growth and returns to shareholders over the long term.
2. Micron Technology
Micron Technology (MU -7.12%) is one of the leading suppliers of dynamic random-access memory (DRAM) and non-volatile memory (NAND) used in several products, but most notably in PCs and data centers. The stock has surged to new heights this year, as high-performance memory modules are starting to see exploding demand from AI servers.
The memory and storage markets are notorious for cyclical swings in demand and pricing. Last year, plunging prices for memory were the main factor that caused the semiconductor industry to report an 8% decline in revenue.
But AI is pulling Micron's business out of the slump, driving the company's revenue up 58% year over year in the most recent quarter, and management expects more growth.
Most importantly, Micron's bottom line is benefiting due to the short supply of high-performance memory chips. In the fiscal second quarter, the company reversed last year's earnings-per-share loss to a gain of $0.71. Strong demand from the data center market should support favorable pricing trends, and therefore boost the company's earnings growth.
The risk is that a sharp increase in data center infrastructure spending might create an oversupply of chips for the data center market and pressure memory selling prices. However, Micron has another card up its sleeve to drive growth, which is a recovery in the consumer PC market. The company is performing well to start the year, but it's not firing on all cylinders yet.
The cyclical nature of the business is the main risk to watch out for, but the current consensus estimate has earnings per share reaching $1.02 this fiscal year before surging to over $9 next year. AI demand could lead to new record highs in revenue and earnings, which could send Micron's share price soaring over the next several years.
