What No One Is Telling You About the Semiconductor Market
Top-Down Analysis Part III, Sector I
The first time I ever did "qualitative research" into specific sectors, I landed on AI and Big Data. Sounds impressive, right? Like I had some grand vision of the future? Yeah, not so much. This was early 2021, and my "research" consisted of skimming a few Seeking Alpha articles about the "Top 5 Sectors for 2021 and Beyond." Armed with my vast five minutes of expertise, I threw some money into a sector-specific ETF. Miraculously, it made me some solid returns.
Now, let’s be honest—it was pure, unfiltered, dumb luck. Back then, I had about as much understanding of AI as my grandmother has of TikTok. I couldn’t have explained machine learning if my life depended on it, and the idea that AI would take over everything from finance to healthcare? Completely beyond me.
Today, we’re going to approach things differently.
First, For those new to this series, here’s a quick recap. We’re conducting a top-down analysis, a method where we start from a macro perspective—identifying major global trends—before drilling down into sectors and eventually landing on a specific company. In Part I, we explored the three megatrends shaping the future: Digitalization, Aging Demographics, and Sustainability. Then, in Part II, we used a structured, data-driven approach to narrow down the most promising sectors within these trends, selecting one sector per megatrend that showed the best investment potential.
Also don’t miss out on our extra part of this series!
Now, in Part III, I’ve done qualitative research on the three finalist sectors from last time: Healthcare Support Services, Environmental & Waste Services, and Semiconductor Equipment. We will split this part into three different posts because otherwise it would be too much to summarize into one e-mail. In this post, we will focus on the Semiconductor Equipment sector. The next parts will be released tomorrow and the day after, covering the remaining two sectors in depth.
The goal of this series is to identify one company that is truly investment-worthy.
Rather than overwhelming you with every tiny detail, I’ll be focusing on the key findings of my research. And don’t worry—there will be a future installment where we break down exactly how to conduct this type of sector-level qualitative research, so you can apply it to your own investment process. Now, let’s get into the good stuff.
Semiconductor Equipment: The Brains Behind the Digital Revolution.
Semiconductor Equipment, a sector that has quietly become one of the most critical pillars of modern technology. Every piece of cutting-edge hardware—whether it’s AI-powered data centers, self-driving cars, or the latest iPhone—relies on semiconductors. But behind the scenes, an elite group of companies provides the specialized machinery that makes semiconductor production possible. Without them, the entire tech industry grinds to a halt.
And here’s the ironic part: after all my self-deprecating jokes about blindly stumbling into AI investments in 2021, I now find myself, once again, knee-deep in AI research. So, consider this my redemption arc—I’m actually trying to do it right this time.
So, what makes this sector so attractive from an investment standpoint?
Trust the Process
To understand why semiconductor equipment is so valuable, let’s break down how chips are made. The process is incredibly complex, requiring precision at microscopic levels. Here’s where specialized equipment comes into play:
Lithography – Think of this as printing a blueprint onto a silicon wafer. Machines like those from ASML use extreme ultraviolet (EUV) light to etch tiny circuits onto the chip. These circuits act as highways for electrical signals, allowing billions of transistors to communicate and process information, making everything from your smartphone to AI servers possible. The smaller the chip, the more advanced the machine needs to be.
Deposition & Etching – Once the blueprint is set, layers of materials are added and carefully removed to shape the tiny transistors. This requires machines that can place and cut materials at a scale thousands of times smaller than a human hair.
Inspection & Metrology – When you’re working on such a tiny scale, even the smallest defect can ruin an entire batch of chips. Specialized scanning machines check for imperfections and make sure everything meets the high precision standards.
Packaging & Testing – After production, chips are cut, enclosed in protective casings, and tested to ensure they function properly. Without reliable testing equipment, a faulty chip could end up in millions of devices.
High Margins, High Demand, and No Easy Way In
As chips keep getting smaller and more complex, the equipment needed to make them must also evolve. This constant innovation makes semiconductor equipment manufacturers incredibly valuable, creating a moat around the few companies that can build these cutting-edge machines.
But it's not just the technological edge that makes this industry so powerful. The barriers to entry are immensely high. Beyond the years of R&D and specialized expertise required, building these machines demands enormous capital investments. The cost of developing and producing this equipment runs into the billions, making it nearly impossible for new players to break into the market.
Additionally, many semiconductor equipment manufacturers enjoy strong pricing power. Since only a handful of companies can produce the most advanced machines, they have the leverage to set premium prices. Take Applied Materials, for example—one of the key players in semiconductor fabrication equipment. With its dominance in materials engineering solutions, it can charge hefty sums for its critical tools, and customers have little choice but to pay up. In fiscal year 2024, the company achieved a gross profit margin of 47.5%, reflecting its ability to command premium prices for its specialized machinery.
Lastly, let’s not forget the massive demand for chips. If there’s one thing AI has made clear, it’s that semiconductors are the lifeblood of modern technology. From AI-driven data centers to autonomous vehicles, everything needs more processing power. And if you’ve seen the capital expenditures (CapEx) of Big Tech in AI development, you’ll understand that demand isn’t slowing down anytime soon. The semiconductor equipment industry sits at the heart of this explosion, ensuring its relevance and profitability for years to come.
A Moat With Cracks
While the semiconductor equipment industry boasts incredible strengths, it’s far from immune to risks. In fact, the very importance of semiconductors in the future has placed the entire industry under intense global scrutiny. Governments are well aware that chips are the power source of tomorrow, and they are determined to keep control. This has already led to export bans, subsidies, and political interference. The U.S. government, for example, has restricted ASML from exporting its most advanced EUV lithography machines to China. ASML isn't even a US company! Such geopolitical maneuvering creates significant uncertainty about the industry's future, and if there’s one thing investors hate, it’s uncertainty.
Another challenge is the high customer concentration. Just as there are only a few key players producing semiconductor equipment, the number of buyers is equally limited. A handful of chip manufacturers dominate demand, and while this hasn't hurt margins—because these machines are irreplaceable—losing even one major customer could have disastrous consequences for revenue and profitability. One big client in financial trouble, means trouble for the entire industry. This risk becomes even more glaring when considering that one of the biggest buyers, TSMC, is located in Taiwan—a region China has long desired to reclaim. Any escalation in tensions could disrupt the industry in ways that are difficult to predict.
Competition is another growing concern. With high profitability comes increased interest, and while the technological barriers are enormous, that doesn’t mean new players won’t try to break in. The recent DeepSeek debacle in China serves as a reminder that disruption doesn’t always come from within the established elite.
Lastly, the semiconductor industry remains cyclical. While the rise of AI, cloud computing, and automation may smooth out some of these fluctuations in the future, the industry still experiences boom-and-bust cycles today. A prime example is the recent inventory reduction by automakers, which led to a temporary slowdown in semiconductor demand. While long-term trends suggest a more stable future, the reality is that for now, semiconductor equipment manufacturers must still navigate the industry's cyclical nature.
Conclusion: High Potential, High Risk
Among the three finalist sectors we selected in Part II, Semiconductor Equipment is undeniably the one that is most aligned with the future. However, it’s also the one that carries the highest risks, something most “experts” won’t tell you. The sharp-eyed Warren Buffetts among you may have noticed in Part II—even though we didn’t highlight it at the time—that the Cost of Capital (COC) for this sector was significantly higher than that of our other two finalists. If you haven’t checked yet, I highly recommend revisiting Part II to see the numbers for yourself. We believe that this elevated COC is entirely justified. With the entire geopolitical landscape laser-focused on semiconductors, the risks associated with political interference, supply chain disruptions, and regulatory constraints are too large to ignore.
On top of that, the sector’s high customer concentration is another red flag. While margins haven’t suffered from this dynamic, the potential loss of a key client could be catastrophic. The fact that one of the biggest buyers, TSMC, is based in Taiwan, only adds to the uncertainty, given China’s long-standing ambitions over the region. And let’s not forget that while barriers to entry are immense, technological disruption is always lurking. The DeepSeek debacle in China reminded us that even industry outsiders will attempt to shake things up. Lastly, despite the increasing importance of AI and cloud computing, the industry still exhibits cyclical characteristics, as evidenced by the recent inventory corrections by automakers.
Because of these risks, we have decided to eliminate Semiconductor Equipment from our final selection. This doesn’t mean the sector is uninvestable—far from it. But we believe the other two sectors we have in store for you, will bring better risk-adjusted results.
So, what’s next? Tomorrow, we dive into Environmental & Waste Services. And for those of you thinking that just because we’re covering it second means it won’t win—well, you might just be in for a surprise…
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💬 What do you think? Drop a comment below and let us know which sector you would have picked!
