If you want to beat the average market return, you need to find companies with better growth prospects than the average company. The S&P500 has delivered median annual earnings growth of 11% since 1989. One sector in which demand is increasing and which is experiencing above-average profit growth is the semiconductor industry.
Let’s take a look at two chip stocks that could crush the market’s returns over the next five years.
1. Gun ownership
Arm Holdings (NASDAQ:ARM) is a highly profitable company that licenses its chip designs to other semiconductor companies. Nvidia, AppleAnd Amazon are some of the more prominent clients. The stock price is up 104% year to date, outperforming the S&P 500’s 15% return.
Companies that can deliver strong top-line growth and consistently translate that into growing profits, or free cash flow, typically earn a premium valuation over time, and Arm certainly meets those standards. Last year, the company generated $907 million in free cash flow on $3.2 billion in revenue, which is a healthy margin of 28%.
Arm processors are used in almost every smartphone worldwide, but there is a growing demand in the data center space. Revenue grew a robust 47% year-over-year in the most recent quarter. Arm-based chips are highly valued for their cost-efficiency and energy savings, which will become important factors for companies to consider as they ramp up their investments in data center infrastructure.
As more data centers become optimized for artificial intelligence (AI) workloads, AI training will require a massive increase in energy consumption. Goldman Sachs estimates that data centers will use 8% of all U.S. power by 2030, up from 3% in 2022. This could fuel substantial growth for Arm’s business.
Alphabet‘s Google recently announced its new Arm-based central processing unit (CPU) for data centers. Google credited Arm’s industry-leading performance and energy efficiency for its implementation on Google Cloud.
New markets such as data center and automotive solutions could flourish and benefit Arm Stock over the next decade. The Wall Street consensus expects Arm’s earnings per share to grow 31% year over year, which would be more than enough to outperform the S&P 500.
2. Broadcom
Broadcom (NASDAQ:AVGO) shares spiked after the latest earnings report. Investors sense a huge opportunity for this leading provider of data center networking and software solutions. Revenue grew 43% year-over-year in the most recent quarter, a sharp acceleration from previous single-digit growth rates. This above-average growth helped the stock rise 43% this year, nearly tripling the S&P 500’s return.
Broadcom supplies the basics of data centers, such as Ethernet switches and high-quality interconnects. These components are in high demand as part of the broader build-out of the AI ​​infrastructure. Broadcom said network revenue grew 44% year over year in the quarter.
Broadcom also offers software solutions, adding to the breadth of its product offering and competitive advantage. The addition of VMware’s software revenue following its acquisition last year could help the company’s growth prospects. The company said the addition of VMware was largely responsible for increasing software infrastructure revenue 175% year over year last quarter.
Broadcom has been around for many years and supplies smartphones, electronic displays and servers. In particular, it focuses on new markets that are profitable and can increase margins over time, meaning the opportunities presented by AI can significantly increase profits and drive the stock price higher.
AI revenues increased 280% year over year last quarter, and management now expects these revenues to account for a fifth of total revenue, but is likely to grow much larger in the coming years.
Analysts expect Broadcom’s profits to grow nearly 17% annually over the long term. Investors can expect the stock to perform roughly in line with future earnings growth. Assuming it performs in line with these estimates, the stock should outperform the S&P 500.
Should You Invest $1,000 in Arm Holdings Now?
Consider the following before purchasing shares in Arm Holdings:
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, a director at Alphabet, is a member of The Motley Fool’s board of directors. John Ballard has positions at Nvidia. The Motley Fool holds positions in and recommends Alphabet, Amazon, Apple, Goldman Sachs Group and Nvidia. The Motley Fool recommends Broadcom. The Motley Fool has a disclosure policy.
Two semiconductor stocks that could outperform the S&P 500 over the next five years were originally published by The Motley Fool
