Folly

AI, semis, and staying disciplined

I think we’re at a point in this market where it’s more important than ever to know what you actually own, and why you own it.

I know. That sounds obvious. It’s the thing you’re supposed to figure out before you ever buy a stock. But in certain markets it becomes easier to forget. Prices go up, everyone feels smart, the hot stuff keeps getting hotter, and eventually people start confusing the direction of the stock price with the quality of the decision.

That’s usually where the trouble starts…

“Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.” — John Templeton

I don’t know if we’re in a bubble. Nobody really knows that in real time, and most people who scream “bubble” every week (guilty) eventually become just as useless as the people saying valuation doesn’t matter.

But I do think there are pockets of the market where expectations have moved from optimistic to goofy.

Semiconductors and many of the names riding the AI wave are probably the most obvious example.

The Philadelphia Semiconductor Index (SOXX) is sitting at all-time highs, up ~53% YTD and roughly ~153% over the past year.

Most of the names inside it are historically very cyclical businesses — and some don’t even look that expensive right now, which is sort of the point.

Cyclicals can look quite cheap at/near the top of a cycle.

None of this is to bash NVDA or AMD or AVGO. These are great businesses and the growth has been nothing short of remarkable. But that kind of growth doesn’t last forever, and the market is starting to price parts of the group like it might.

But even if you believe the AI story, this move in semis has gotten pretty ridiculous. Through Friday’s close, SOXX has logged 18 consecutive up days — the longest winning streak in its history. The previous record was 15 sessions back in 2014, and that one delivered a gain of about ~8%. This streak has delivered roughly ~45%.

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April is on pace to be the biggest monthly gain in semis since February 2000. If that month doesn’t ring a bell, ask someone older.

Here’s where some of the actual names inside the index are trading right now:

I’ll give it to NVDA. At ~25x forward earnings, that one you can actually defend. Highest revenue growth in the group at ~65%, cleanest financials, the most direct line to where the spending is actually going. It’s also been the worst performer on the page — up “only” ~12% YTD while everything around it has gone vertical.

The rest is where the math starts to get… silly.

AMD at 52x forward and 133x trailing, after running ~69% in a single month. AVGO at 31x forward, 82x trailing. ARM at 121x forward and 313x trailing, up ~102% in three months. Intel at 80x forward, up 87% in a single month and ~123% YTD on TTM revenue growth of 1.4%. ON Semi printing 339x trailing earnings while its top line is actually contracting ~15% year-over-year.

Even the technicians are openly calling the move parabolic at this point.

The hard part is that the underlying story is very much real. AI may be the biggest tailwind the chip industry has ever seen. Demand for compute is exploding, hyperscaler capex is still going vertical, and every CEO wants some attachment to the AI story. A lot of that is true. Honestly, most of it probably is.

The problem is that a great story still has to clear the price you pay for it. And right now, for a lot of these names, the price already assumes the story plays out almost perfectly. There’s no real margin of safety left. The thesis has to land almost exactly as drawn up just to earn a decent return from here. Anything less and you’re underwater.

That doesn’t make any of these names wrong to own. It just means there’s no room for error. There’s a real difference between owning a great company and owning a great company at a good price…

Understand What You Own

This is the exercise I keep running on myself.

If I had to defend every position I’m holding to a smart friend who didn’t already agree with me, could I do it?