2 little-known semiconductor stocks to buy for 2023

Chip stocks have been down, but they’re far from finished. In fact, global chip sales are expected to take an epic streak over the next decade, driven by a myriad of secular growth trends ranging from cloud computing to artificial intelligence (AI) to electric vehicles. Various estimates suggest that the semiconductor industry will grow from around $600 billion in 2022 to well over $1 trillion by the end of the decade.

However, it will be a bumpy climb as chip sales are cyclical. In fact, a down cycle is in effect right now. But two little-known but crucial companies for the semiconductor industry – Synopsys (SNPS 1.64%) and Cadence design systems (CDNS 0.60%) – could be fantastic investments along the way. Because of that, these two software games in the computer hardware space are key stocks to consider for 2023.

The next wave of computer innovation is happening now

To take computing power to new levels, chip designers are exploring new ways of packaging semiconductor systems—such as chiplets, multiple smaller chips assembled into a larger integrated circuit. Some chip designers like intel I think multiple vendors will be involved in supplying the parts for a chiplet computing architecture model.

Other innovations include embedding software in chips early in the design process. Software technologies are also helping to reduce development times with features such as simulation of chips at the molecular level, AI tools to solve design problems, and the use of ready-made customizable circuits to speed up the overall design.

All of this requires a complex suite of software to coordinate all the different engineering teams and stakeholders involved in the development of modern computer systems. This is where Synopsys and Cadence come in. There’s a lot of overlap between what these two software companies do, but together — along with Mentor, which is now owned by a German industrial conglomerate Siemens — they are a critical part of the chip industry, known as Electronic Design Automation (EDA) software. Be it a semiconductor designer, a chip manufacturer, a computer systems assembler or a software developer, there is a good chance that Synopsys or Cadence is an important part of the software suite used.

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And since Synopsys and Cadence are primarily subscription-based models, they show consistent growth numbers. That’s in stark contrast to many other chip companies, which ebb and flow with the economy or semiconductor sales cycles.

Chart of CDNS revenue (TTM).

Data from YCharts.

The result is a differentiated share price development. Because of their similarities, Synopsys and Cadence stocks trade in close lockstep, but both are easily beating the market in 2022.

Put these two stocks on your watch list

I put off buying Synopsys or Cadence Design based on their top notch reviews. But as 2023 approaches and the next wave of computing technology begins to be commercialized, I’m ready to start buying. I’ll use a dollar cost average method and probably add to one or both stocks monthly early next year.

The premium price tags for both (Synopsys trades for 32 times trailing-12-month free cash flow, Cadence for 42 times) seem well-deserved. Both companies are growing steadily, are highly profitable, have excellent balance sheets and are buying back shares.

Metric

Synopsys

Cadence design systems

Sales growth in the last quarter

11.5%

20%

Running 12 Month Operating Profit Margin

23.1%

30.8%

Trailing 12-month free cash flow margin

31.5%

31.7%

Trailing 12 Month Share Buybacks

$862 million

$865 million

Total cash and short-term investments

$1.57 billion

$1.09 billion

total debt

$20.8 million

$798 million

Data sources: Synopsys and Cadence Design Systems.

A note to keep in mind: Cadence recently acquired molecular modeling and simulation software company OpenEye Scientific, which it also took on some new debt to purchase. Synopsys also grew revenue 21% in its recently concluded fiscal 2022, so the growth profiles of the two companies are much closer together than the most recent quarter would suggest.

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But make no mistake, a decade of advancements in computing technology is upon us. Synopsys and Cadence Design will play key roles in its development and commercialization. As such, I think these two stocks should be staples for semiconductor investors in 2023.

Nicholas Rossolillo and his clients have no position in the stocks mentioned. The Motley Fool has positions in and recommends Cadence Design Systems, Intel, and Synopsys. The Motley Fool recommends the following options: long January 2023 $57.50 calls on Intel, long January 2025 $45 calls on Intel, and short January 2025 $45 puts on Intel. The Motley Fool has a disclosure policy.

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