JP Morgan loves the prospects for this obscure part of the tech sector

Published Wed, Jun 6 201812:16 PM EDT

Investors should expect strength in semiconductor equipment manufacturers through 2019, according to J.P. Morgan, as demand for chips goads companies like Applied Materials and Lam Research higher. Analyst Harlan Sur added that he anticipates wafer fab equipment (WFE) – essential to the production of electrical circuits like LEDs and radio frequency chips – spending to hold near $50 billion, well above the average of $32 billion seen between 2010 and 2016. "Demand remains strong across device types at the leading edge, driven by data center compute, networking and storage," analyst Harlan Sur said in a note to clients Wednesday. "We believe a steady semiconductor unit growth environment, disciplined supply chains and rational (and strategic) investments amid a broad-based end-market demand environment should lead to steady growth in WFE spending beyond 2018." In highlighted the industry as a potential bid for savvy investors over the next year, J.P. Morgan's analysts reiterated their overweight rating on shares of both Applied Materials and Lam Research, two chip equipment makers that would likely benefit from the persistent demand. Sur noted that such equipment manufacturers will gain from further market share gains and an overall expansion of the addressable market, in turn driving free cash flow. Unlike prior investment cycles that were defined by end markets like personal computer and smartphones, analysts are now seeing continued strength in storage and networking led by requirements for cloud service providers. "Given our view of a more predictable, less cyclical technology-driven capital spending environment – well-aligned with stable semi industry unit growth rates – we expect companies under coverage to drive further operating and free cash flow margin expansion and increase capital returns to shareholders," the analyst added. "Leading edge devices are difficult to manufacture and capital intensity for these devices continues increasing, including technology transitions on the memory side." Though shares of both Applied Materials and Lam Research fell Wednesday, the semiconductor trade has been one of the hottest on Wall Street over the past 18 months. Names like Nvidia and Micron provided investors with protection during the year's volatile start and are up 78 percent and 85 percent respectively over the past 12 months. The iShares PHLX Semiconductor ETF is up 14 percent year to date compared with the S & P 500's 2.8 percent return.

A technician checks on a stack of wafers at the Applied Materials facility in Santa Clara, California.

David Paul Morris | Bloomberg | Getty Images

Investors should expect strength in semiconductor equipment manufacturers through 2019, according to J.P. Morgan, as demand for chips goads companies like Applied Materials and Lam Research higher.

Analyst Harlan Sur added that he anticipates wafer fab equipment (WFE) – essential to the production of electrical circuits like LEDs and radio frequency chips – spending to hold near $50 billion, well above the average of $32 billion seen between 2010 and 2016.