Semiconductors are the foundation upon which artificial intelligence (AI) thrives, but knowing that is only part of the battle. For investors using ETF to access chip stocks, some homework could pay dividends regarding identifying the chip ETFs with the most AI relevancy.
The VanEck Semiconductor ETF (SMH) is among the ideas that come to mind. The $11.7 billion SMH turned turned 12 years old in December. It was higher by nearly 73% as of December 26. That’s a stellar performance to be sure. And it’s one that’s been fueled in part by the fund’s robust AI adjacency.
As a semiconductor play on AI, SMH’s construction is highly pertinent to interested investors. Three of the most widely held stocks by AI and big data funds, including ETFs, are Advanced Micro Devices (AMD), Nvidia (NVDA) and Taiwan Semiconductor (TSM). That trio represents three of SMH’s top four holdings.
Moats Matter
Nvidia and Taiwan Semiconductor combine for 28.46% of the SMH roster. That’s relevant on multiple levels, not the least of which is Nvidia is viewed as one of the most AI-relevant stocks, particularly in the chip space.
Still, SMH’s more than 9% weight to Taiwan Semiconductor shouldn’t be glossed over. After all, that company is the largest chip foundry operator in the world. That means that as demand for AI chips increases, so will demand for Taiwan Semiconductor’s services. That speaks to Taiwan Semiconductor’s status as a wide moat company — a trait shared with Nvidia.
“Companies with economic moats could be more likely to benefit and may be less susceptible to disruption from AI than those without moats. Moats based on a combination of customer switching costs, unique datasets, and brands could be particularly valuable,” noted Morningstar. “Companies with durable advantages could use AI to improve their products and services and strengthen their competitive positions.”
Competitive Advantages Have Myriad Appeal
The durable competitive advantages possessed by Nvidia and Taiwan Semiconductor are appealing for other reasons. As Morningstar points out, companies with that trait are usually profitable. They usually generate significant amounts of free cash flow. That could be advantageous in turbulent economic climates. Overall, SMH remains a valid AI consideration. That’s particularly so for market participants that want to eschew stock-picking in a still-evolving niche.
“Artificial intelligence is an exciting theme, and we expect a lot of market interest in 2024. One effective way to access the AI theme without paying huge valuation premiums is via second-derivative plays. These are not the chipmakers or those that offer technology interfaces. Rather, it’s those who can effectively embed AI into their workflow and drive new revenue growth opportunities. The principles of good investing still apply,” concluded Morningstar.
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