Our guide to semiconductor companies and how their chips run our everyday lives

Published Tue, Nov 1 20223:38 PM EDTUpdated Tue, Nov 1 20223:39 PM EDT

The semiconductor, or chip, industry is perhaps one of the most important and complex sectors in the stock market to understand. Chips are in everything from our smartphones to cars and to all facets of computing, from PCs to massive data centers used for the cloud. Put simply, they are the bricks and mortar of the digital world. We don't see them, but we know they magically make stuff work. Semiconductor companies are also in the news a lot lately, whether it's the U.S. government cracking down on chip exports to China or innovations in connected cars and artificial intelligence. But that doesn't make the industry any easier to understand, even for those familiar with the well-known players. Making things trickier: The market tends to bucket anything chip-related into broad-based investment vehicles, such as exchange-traded funds (ETFs) and mutual funds. These companies, however, are quite specialized. Despite the industry being out-of-favor right now – and our ongoing effort to scale back our once over-weighted chip holdings – we believe that investors' portfolios should have at least some exposure to the industry. For starters, they are crucial to nearly all secular growth trends today and into the future. And trying to time the booms and busts of the cycle is incredibly difficult if not impossible to do consistently. In our portfolio, we have small positions remaining in Advanced Micro Devices (AMD), Nvidia (NVDA), Marvell Technology (MRVL) and Qualcomm (QCOM) — all of which design chips for varying uses. ( We'll get into the specifics later ). Here then is our guide to all things semiconductor. Our goal is to help you better understand where different chip-related companies sit in the supply chain, to differentiate these companies by their end markets, and to gain more insight on how money flows through the industry. After all, one company's capital expenditure is another company's revenue. What is a foundry model? The term foundry is industry jargon, referring to the factory where chips are made. There are four main categories in the supply chain under this model: Capital equipment makers, pure-play foundries or fabs, fabless designers, and integrated device makers. Capital equipment companies — such as Applied Materials (AMAT), Lam Research (LRCX), ASML Holdings (ASML) and KLA Corporation (KLAC) — make the machines used in the manufacturing of semiconductors. Pure-play foundries , or fabs, are companies with factories that fabricate (manufacture) chips designed by other firms (some designers have their own factories but we will touch on that below). In these monstrous facilities, you will find the capital equipment made by the capital equipment makers. That alone should provide some insight into the money flow, because when a foundry is being updated or built from scratch, a good deal of that spending is going to go into buying equipment from the capital equipment makers. When you hear commentary on a call from a foundry player about capital expenditure plans, just remember that what you're also hearing is commentary on demand and revenue for capital equipment makers. Players in the foundry space include companies such as Taiwan Semiconductor Manufacturing Company (TSM), often referred to as just TSMC, and GlobalFoundries (GFS). Fabless designers generally outsource the chips they draw up to foundries. Again, we can start to see the flow of funds, as strong guidance from a fabless designer means high demand — and therefore, a need for a greater number of chips. Of course, the more chips a company needs, the greater the order value it will place with a foundry player such as TSMC. Fabless designers include our Club holdings Nvidia, AMD, Marvell Technology and Qualcomm. Since these companies don't need to invest in expensive fabrication facilities, they can run a more agile asset-light business model. They don't have to concern themselves with the need to lay out significant capital in order to ensure their ability to manufacture the most cutting-edge chips. Finally, integrated device companies design and manufacture their own chips in-house, essentially designers with their own foundries. Players in this group include Intel (INTC