First Eagle’s Small Cap team believes small and microcap stocks represent a particularly volatile and inefficiently priced segment of the US equity market—and that these dynamics can create opportunities for disciplined active investment managers. In The Small Idea series, the team offers its perspective on some of the themes and trends impacting this large, diverse pool of domestic companies.
At a time when headlines are dominated by multi-decade-high inflation prints, shifting fiscal and monetary policy, rising interest rates, geopolitical tensions and global health concerns, this golden rule serves as a great reminder of an approach that historically has worked well in the small cap equity market. While we can think of more than a few industries that could benefit from greater investor focus on business execution and opportunity amid the many external distractions, one stands out: semiconductor capital equipment companies.
In his 1993 classic Beating the Street, famed value investor Peter Lynch listed “25 Golden Rules” that summarized what he believed to be the most important lessons learned in his career. One in particular stands out in our minds as we consider today’s market environment: “Nobody can predict interest rates, the future direction of the economy or the stock market. Dismiss all such forecasts and concentrate on what’s actually happening to the companies in which you’ve invested.”1
At a time when headlines are dominated by multi-decade-high inflation prints, shifting fiscal and monetary policy, rising interest rates, geopolitical tensions and global health concerns, this golden rule serves as a great reminder of an approach that historically has worked well in the small cap equity market. While we can think of more than a few industries that could benefit from greater investor focus on business execution and opportunity amid the many external distractions, one stands out: semiconductor capital equipment companies.
Our work in the capital goods sector has led us to invest in several companies that make equipment to support the production of semiconductor chips and integrated circuits (ICs), ranging from designers and builders of semiconductor manufacturing systems to providers of the equipment and services to test and inspect chips. As value managers, we seek to buy companies that we believe are trading with good value metrics—i.e., that appear cheap—but that also offer very good growth potential. In our view, a small handful of highly specialized semiconductor capital equipment companies are likely to benefit from the current buildout in semiconductor manufacturing capacity worldwide.
Semiconductor manufacturers have been ramping up production in the face of a global chip shortage. Despite new records for global chip sales and units shipped in 2021—$555 billion on 1.15 trillion units—demand continues to outstrip supply.2 A recent report from the Commerce Department found that median demand for chips—driven in part by a shift to more semiconductor-intensive products in day-to-day consumer use, such as 5G cellphones and electric cars—was 17% higher in 2021 compared to 2019. Buyer inventories have fallen from 40 days to less than
five days over that same period, and are even smaller in key industries like medical devices, broadband and autos. Insufficient fab capacity has been targeted as the key bottleneck, and while semiconductor companies in 2021 and 2022 have ramped up capital expenditures at a rate never before seen, ambitious projects take time to come online.3
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