Even though semiconductors and microchips are such an integral part of the global economy, there are still some chip stocks to avoid. It’s not because of a lack of demand or even customers, considering that nearly every country in the world needs microchips for one reason or another. Rather, the warning signs can be more insidious for retail investors who may not be the most familiar with the chip industry.
Sometimes, it can come down to intangible factors, like a lack of experienced personnel or unpredictable shifts in governmental policies. Other times, the microchip company may have everything it needs to succeed but simply doesn’t due to customer demands.
I’ve had the pleasure of touring some of the world’s premium chip manufacturers, and I realized one thing about how they’re made. No matter the success rate or efficiency of a microchip production line, anything that can go wrong will go wrong.
Intel (INTC)
Many analysts have been bearish on Intel (NASDAQ:INTC) and its role in bringing chip manufacturing back to America. Currently, the frustration comes to the company’s foundry unit losing $7 billion in 2023, but the issue may be deeper than that. For instance, some chip foundries experience issues with “scrap rate,” which essentially means how many chips in a batch fail the manufacturing process before passing inspection.
In some cases, the design of a chip can be so complex, that scrap rates reach up to 70%, meaning yield is only 30%. So for an order of 100 high-complexity chips with a yield of 30%, the manufacturer may have to make 300 chips or more just to make enough acceptable ones for the customer.
There’s a good chance this is what is what’s happening to Intel and as such the company may be losing money to court customers with special design requirements. Unfortunately, operating attrition at such high levels will continue to erode investor faith, putting INTC in the category of chip stocks to avoid.
Wolfspeed (WOLF)
A specialist in the silicon carbide variation of semiconductors, Wolfspeed (NYSE:WOLF) has struggled to manage the costs of its expansion. The company’s primary market is Europe, which has also added a layer of complexity to its manufacturing operations in Germany due to the current economic conditions leading to a contraction of the German economy. Thus, the high cost of manufacturing may not be as palatable to long-term customers and investors looking for a profitable chip company.
In its Q3 report for its FY2024, the company’s GAAP gross margin reduced by 20%, down to 11% from last year’s 31%. This suggests the company may have high underutilization costs as a result of a lack of captured customers. One reason for this is the relatively complex nature of WOLF’s focus on gallium nitride and silicon carbide boards.
These are incredibly efficient for power conversion technologies but currently lack widespread adoption in commercial industries. Thus, until the company can solidly begin to retain customers and scale production to sustainable cost levels, it will remain among chip stocks to avoid.
TTM Technologies (TTMI)
Despite strong financial performance and improved profitability, there could be some deeper issues with TTM Technologies (NASDAQ:TTMI) that investors should be aware of. This concern stems from the company’s closure of its Anaheim plant in October of 2023, which left several customers without a critical supplier.
Admittedly, the closure of the Anaheim plant was financially healthy for TTMI at the time. However, it exposed a flaw in the company’s business model. That is, TTMI operates like a large conglomerate of what were once independent manufacturers. As a result, each plant it owns has its own areas of expertise and machinery needed for specific levels of circuit board complexity.
Furthermore, due to the controlled U.S. defense industry, which accounts for 46% of TTMI’s revenues, each plant must qualify as a part of a customer’s product line. These plants cannot change without downstream customers’ approval. Thus, the closure of a plant for TTMI, should it happen again, represents the loss of the customers who relied on that specialized and qualified plant, which significantly hinders the company.
On the date of publication, Viktor Zarev did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.