Index Funds VS
Semiconductor Stocks
Index funds have always seemed like the boring drone of the investment community when compared to the high flying world of individual stock picking,
especially the highly volatile world of semiconductor stocks. Bragging to your buddies that you achieved the same investment return as the
S&P 500 just doesn't make you sound like the overlord of investment prowess now does it?
The mutual fund industry also has a vested interest in making you believe that individual stock picking is the ultimate strategy as well...er, ah, well, that is,
it's only the ultimate strategy if you pay them to do the stock picking for you. After all, how could you possibly manage to pick stocks as well as their highly paid
professional fund managers?
Never mind the historical fact that about 87% of the actively managed mutual funds lagged their investment index. And of the mutual
funds that did manage to beat their index, about 34% of them failed to beat their index the following year.
Investment Magazine Advice
Investment magazines are just as guilty of perpetrating the individual stock picking myth as well. Let's face it, trying to sell a weekly or monthly magazine without the
"10 Best Mutual Funds" or "10 Hottest Stocks" might be a little tougher. Providing the same investment advice
for every copy might start to wear thin on their paying subscribers.
How many editions would you buy with "Buy Index Mutual Funds" on
the cover? Not too exciting is it?
In fact, the inspiration for this article came from one of my
favorite investment magazines - Forbes. Specifically, the
article was in their Money and Investing section and titled
"A Power Portfolio".
Stock Investing Disasters
While I'm a huge Steve Forbes fan, I just couldn't buy off on the horrible investment advice provided in this article. The basic concept of the
article is to invest in the component companies that will supply the automotive manufacturers with the semiconductor components to produce the hybrid cars
of the future.
Hybrid cars are certainly a popular niche, with heady growth forecasts, so why do I hate this investment advice?
I believe this investment strategy is wrong on so many levels that I'm not
sure that anyone could really benefit from it but let me elaborate on my top
reasons:
- Investment Time Duration
2015 is when the
article authors believe that these companies "should be cashing in".
Great news...now when should you buy this list of companies?
Buy them now and wait 10-years or wait until 2014 to jump in?
- Too Many Variables
Not only do you need to
predict which technology path cars will ultimately take in 2015, you
also need to accurately predict which auto makers will thrive and
then predict which suppliers they'll use.
- That's 3 major variables you need to get right!
- Recommending Competitors
The 8 semiconductor
companies recommended as "winners" in this industry also happen to
be competitors. How can they all be winners when they're
competing for finite design slots?
- Some will win so some will naturally have to lose!
- Which ones will
you own? (Share price listed as of April 1, 2005)
- - Cree ($21.30)
- Diodes ($27.06)
-
Fairchild Semiconductor ($14.96)
- Infineon Technologies ($9.50)
- International Rectifier ($44.20)
- Ixys ($11.69)
- On Semiconductor ($3.92)
- Siliconix ($35.29)
- Commodity Suppliers & Low Margins
Since the
products these 8 companies are essentially "commodity
semiconductors", the price wars are fierce. New products are
the significant margin driving factors for semiconductors but the auto
manufacturers do not use "bleeding edge" technology.
- Having your computer "crash" while driving through the desert
in the middle of summer might enrage you but having your car stall
in the desert might kill you. This is the reason for the
conservative nature of the auto companies.
- This "technology lagging" mentality is also a margin killer for
commodity suppliers. When all the suppliers have basically
equivalent technology, it always comes down to one thing...PRICE.
- Low Volume
A good year in the global auto
industry is about 40 million vehicles produced. Sounds like a
pretty big number until you compare it to the cell phone industry or
computer industry.
- Would you rather sell a $5.00 part to 10% of the auto industry
or a $.25 part to 10% the cell phone (700M units) and computer
industry (180M units)?
- Auto Industry Revenue....$20,000,000
Cell Phone/Computer Revenue....$22,000,000
- At first glance it's about even but which part do you think will
attract more attention from the customers Purchasing Department and
Cost Reduction Engineering group?
- Hero's aren't made form cost reducing pennies. Industrial
hero's look at the most expensive items first and work down from
there.
- Percentage Of Sales
It's unlikely that any
of recommended companies will ever have their automotive sales
become a majority of their revenue. This implies that other
factors beyond hybrid cars will have a much larger impact on the
stock price in 2015.
- So even if you guess correctly on all counts of the hybrid
debate, you could still be sitting with the loser in the cell phone
or computer wars.
- Too Much Money
To buy even 100 shares of
each of these companies would require investing $16,792. To
keep this high risk investment at only 10% of your balanced investment
portfolio would require a whopping $167, 920 portfolio. To
commit more than 10% of your portfolio to this would be very risky
for most investors.
A Better Option - Semiconductor Index
As a person who has worked in multiple aspects of the semiconductor field
for just under 20-years, and invested in the semiconductor field almost as
long, I can speak first hand of the volatility these stocks present.
While it's true that volatility brings out sized rewards, it also presents
out sized risks.
If you're an insider like I was, you'll make a huge profit with
semiconductor stocks but if you're not living the industry every day
then forget about picking these stocks for investments.
To look out 10-years and predict a winner is a joke to me. With semiconductor technology changing as rapidly as it does, nobody can predict who
the winners will be in 2015. It's close to impossible so don't even try.
So what can you do?
To capitalize from this industry, try an
index fund that follows the SOX
(Semiconductor Index). You'll avoid having to pick the winners
or keep track of the rapidly changing technology trends.
High Risk SOX
Keep in mind though that the SOX index is one of the most volatile and is definitely not for the faint of heart. If the thought of
watching your investment value swing 50% in either direction sounds frightening to you...look elsewhere as this is
probably not for you.
For example, the SOX hit an all time high in 2000 above 1300 but
then lost 80% of its' value, dropping to about 200, by 2002.
It has since recovered to 411 but It's easy to see how this
investment vehicle has been a real train wreck for the
"buy and hold" crowd.
The Best Mutual Fund Option
Imagine how much money was made by the investors that sold the SOX short in 2000.
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Amazing History Lesson
Learn from the history of the stock market and the investors before you. You see, the four most dangerous words in investing are "it's different this time".
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It should not be assumed that future recommendations will be profitable or will equal the performance of the past.
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