Semiconductors Are On Fire

In today’s edition of the Alpha Letter, we cover the following topics:

  • Macro: Key inflation report released today at 8:30am EST, US budget gap grows.

  • Stocks: Semiconductors are constrained by demand.

  • Crypto: What to expect from the Coinbase IPO.

Macro

A key report comes out this morning that will help us understand if inflation is becoming an imminent problem. The March consumer price index will be released today at 8:30am EST; this report will tell us how much prices for a basket of consumer goods rose over the month of March. 

Analysts are expecting low CPI growth at 0.2%, or about the same pace as inflation was just before the pandemic started in January 2020.

CPI increased 0.4% in February of 2021. 

Inflation is one of the biggest, if not the biggest, macroeconomic concern right now. The Federal Reserve’s accommodative monetary policy has been beneficial for markets, liquidity, and most companies. Helping to keep the markets healthy by providing liquidity is overall good for the economy, retirement savings, and the job market.

But the potential downside of pumping money into the system is the risk of increasing inflation. Today’s CPI number will give us an idea of how much we need to worry.

It’s also important to remember that CPI, like any financial metric, can be “gamed” by including or not including certain items. Many investors believe the Fed and other government agencies try to keep CPI on the lower side if possible to avoid causing alarm. 

US Budget Deficit

The US budget deficit grew to a record $1.7 trillion for the last six months, according to data released Monday. The spending deficit increased by $660 billion in just March, partially due to a surge in spending on stimulus checks. 

The deficit is now about twice what it was a year ago. 

Obviously, the budget gap is of concern from a macro perspective. However, there is no reason to panic in the short-term. Some permabears use the budget deficit to raise alarm and justify their predictions of an immediate market collapse. However, the truth is that we’ve had budget deficits for a large portion of US history without massive consequences.

Besides, a budget deficit is more likely to cause a long-term problem for the US government and our currency, but won’t cause a short term stock panic. 

Injecting money into the system via stimulus payments is definitely a good thing for markets, but it comes with the inevitable trade off of increasing the budget deficit. After all, that money needs to come from somewhere. 

If you are worried about America’s long-term financial health and the strength of the US dollar, there is no reason to start shorting SPY. Instead, you should look into owning other currencies or stock in companies who do business in other currencies.

Another idea is diversifying into Asian, European, South American or African ETFs. 

Multinational companies based in the US will still likely do fine even if the US government is having financial problems, so there is absolutely no reason to think a large budget deficit means you should be shorting the markets. 

Stocks

Let’s talk semiconductors. 

Nvidia (NVDA) was up 5.62% Monday after the company improved guidance for Q1. The company said its revenue for Q1 (which ends in May) is tracking to be above the previous guidance of $5.3 billion. 

Semiconductors are a hot space right now. Nvidia is up 125% over the last year, while AMD is up 54%. 

Here are the 15 top performing semiconductor-related stocks over the past year:

The big news in the chip industry is the semiconductor shortage, which is bad news for semiconductor companies and car manufacturers. Demand was surging even before the shortage due to increased global demand for computers and “smart” devices; the new shortage in supply puts a constraint on the sales of chip makers.

Several of these companies are trading significantly below their 52-week and all-time highs.

AMD, for example, is about 20% its all-time high from a few months ago. 

It’s a complicated industry, so you’ll want to dig into the filings for any individual stock you’re thinking of buying. But overall, I believe it’s a great industry to be in. The supply issues will be figured out at some point, and demand will be there for a long, long time.

There are several quality semiconductor ETFs, including SOXX, SMH, and FTXL.

Crypto

Coinbase is set to go public on Wednesday, marking a huge milestone for crypto. In many ways, Coinbase sets the standard for the industry. Starting Wednesday, it will set the standard for crypto exchanges as publicly traded stocks. 

The success (or failure) of Coinbase’s stock could determine if other exchanges like Gemini or Kraken end up going public down the road.

Voyager Digital is one of the few crypto exchanges that’s already public. It trades under the ticker VYGVF, but has received much less attention because it’s an OTC name. 

Coinbase filed its S-1 in February in preparation for going public. The exchange did roughly $1.27 billion in revenue in 2020, more than a 100% increase from 2019. Coinbase is also a rare tech company going public in 2021 in that it has turned a profit.

Coinbase reported a $322 million net profit for 2020, a rare feat for high-flying tech companies.

Coinbase appears to be a healthy, high-growth company that just about anyone would want to own. However, the question will be: at which price do you want to own it?

Many expect that Coinbase will trade over a $100 billion market cap when it debuts tomorrow. Shares will likely be hard to come by on day one. For new companies, shares are typically made available to investment banks’ preferred customers before they’re widely offered to the general public. 

Alpha Thoughts

We’re adding a new section to the newsletter called “Alpha Thoughts”. Before you go about your day, we’ll leave you with one interesting thought or idea that hopefully helps you generate more alpha. 

Guess my valuation

We are adding a new section called guess my valuation. It will be an exercise where you can try to guess what a company’s market cap is and what they do based on the financials only. The answer will be at the bottom of the newsletter.

  • 2020 Revenue: $95 million

  • 2019 Revenue: $123 million

  • 2020 EBITDA: $5.2 million

  • 2019 EBITDA: $25 million

  • 2020 Free Cash Flow: $7.6 million

  • 2019 Free Cash Flow: $18.1 million

  • Normalized Operating Margins: 15.5%

  • Normalized Gross Margins: 25%

What is your guess?

Update for Subscribers

We added a new section for paying subscribers called “Top Idea List”. This will be a fluid list of our top stocks we own, what price we initiated coverage, our price target and any updates. We will be updating this list weekly as we add new research to the list and any updates on portfolio companies. The Top Idea List will be pinned to the top of our Substack so you will be able to find it easy.

The answer to “guess my valuation” is Saga Communications (SGA). Saga is a radio broadcaster with a market cap of $126 million and an enterprise value of $84 million. Did anyone get it right?