If you want to beat the average market return, you need to find companies with higher growth prospects than the average company. S&P 500 has posted median annual earnings growth of 11% since 1989. One sector that is experiencing accelerating demand and is positioned for above-average earnings growth is semiconductors.
Let’s look at two chip stocks that could wipe out the market’s performance over the next five years.
1. Arm Supports
Arm holds (NASDAQ:ARM) is a highly profitable company that licenses its chip designs to others semiconductor companies. Nvidia, AppleAnd Amazon are some of its most important clients. The stock price has risen 104% since the beginning of the year, outperforming the S&P 500’s 15% return.
Companies that can generate strong revenue growth and consistently convert it into growing profits, or free cash flow, typically command premium valuations over time, and Arm certainly fits the bill. Over the past year, the company generated $907 million in free cash flow on $3.2 billion in revenue, which represents a healthy 28% margin.
Arm processors are used in almost every smartphone in the world, but demand is booming in the data center space. Revenue grew 47% year over year in the most recent quarter. Arm-based chips are highly valued for their cost-effectiveness and power savings, which will become important factors for companies to consider as they increase their investments in data center infrastructure.
With more data centers optimized for artificial intelligence (AI) AI workloads and training will require huge increases in power consumption. Goldman Sachs estimates that data centers will use 8% of all U.S. energy by 2030, up from 3% in 2022. That could drive substantial growth in Arm’s business.
AlphabetGoogle recently announced its new Arm-based central processing unit (CPU) for data centers. Google credited Arm for its industry-leading performance and energy efficiency for its implementation in Google Cloud.
New markets like data centers and automotive solutions could blossom over the next decade and benefit Arm stock. Wall Street consensus expects Arm’s earnings per share to grow 31% on an annualized basis, which would be more than enough to outperform the S&P 500.
2. Broadcom
Broadcom (NASDAQ:AVGO) The company’s shares soared after its latest earnings release. Investors see a huge opportunity for the leading provider of networking and software solutions for data centers. Revenue grew 43% year over year in the most recent quarter, a sharp acceleration from its previous single-digit growth rates. That above-average growth has sent the stock up 43% this year, nearly tripling the return of the S&P 500.
Broadcom provides data center essentials, such as high-performance Ethernet switches and interconnects. These components are in high demand as part of the broader development of AI infrastructure. Broadcom said its network revenue grew 44% year over year in the quarter.
Broadcom also offers software solutions, which broadens the breadth of its product offerings and strengthens its competitive advantage. The addition of VMware’s software revenue from last year’s acquisition could benefit the company’s growth prospects. The company said the addition of VMware was largely responsible for its software infrastructure revenue increasing 175% year-over-year in the most recent quarter.
Broadcom has been active in the smartphone, electronic display and server industries for many years. The company is particularly targeting new profitable markets that can increase margins over time, meaning that the opportunities offered by AI could significantly increase its profits and drive up its stock price.
AI revenue grew 280% year-over-year in the most recent quarter, and management now expects that revenue to represent a fifth of its total business, but it will likely see growth much more important in the years to come.
Analysts expect Broadcom’s profits to grow at an annualized rate of nearly 17% over the long term. Investors can expect the stock to perform roughly in line with its future earnings growth. Assuming it performs in line with these estimates, the stock is expected to outperform the S&P 500.
Should You Invest $1,000 in Arm Holdings Right Now?
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John Mackey, former CEO of Amazon’s Whole Foods Market, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. John Ballard has positions at Nvidia. The Motley Fool holds positions and recommends Alphabet, Amazon, Apple, Goldman Sachs Group and Nvidia. The Motley Fool recommends Broadcom. The Mad Motley has a disclosure policy.
2 Semiconductor Stocks That Could Outperform the S&P 500 Over the Next 5 Years was originally published by The Motley Fool
