IT Investor's Journal: How to benchmark semiconductor stocks
Friday June 18, 2004 - [ 07:40 PM GMT ]
Topics: Investment , Management
By: Melanie Hollands
management.itmanagersjournal.com
It's typical to look at two benchmarks in order to gauge the health of the semiconductor stocks. The first is the Philadelphia Semiconductor Index (SOX), which is an index, is traded on the Philadelphia Exchange (PHLX). The second is the Semiconductor Holders Trust (SMH), which is really a type of security called a HOLDR rather than an index. The SMH trades on the American Stock Exchange (AMEX) and is managed by Merrill Lynch. HOLDRs are explained later in this article.
Melanie Hollands
The SOX is an index of 18 semiconductor and equipment names and is more heavily weighted toward the semi cap equipment names than the SMH. The component stocks are included on a market cap weighted basis, and the weights are periodically adjusted. The way it trades can be a little whacked at times because of the weights. But I think watching the SOX's intraday chart is a great indicator for the overall for the direction of the technology sector. The SOX generally leads the tech sector both ways -- up and down. This makes intuitive sense, since an uptick in chip demand then flows into OEMs (such as Dell, Hewlett-Packard, IBM), etc.
The SMH includes 20 semiconductor capital equipment and semiconductor names. The component stocks are included on a market cap weighted basis, and the weights are adjusted from time to time. The SMHs five biggest components currently are INTC (at 22 percent of the SMH), TXN at 15 percent, AMAT at 14 percent, ADI at 8 percent, and MXIM at 6.5 percent.) I typically use the SMH as an ETF (exchange traded fund – see below) to get exposure to a group of large cap semi names. I don't notice any particular characteristics when trading the SMH -- it's really just a trading vehicle for quick large cap semiconductor exposure.
The SOX and the SMH have 15 stocks in common. However, the weightings of the individual components in each basket are different. The SOX is more heavily weighted to the semiconductor equipment companies compared with the SMH, which is more heavily weighted to the semiconductors.
The SMH tracks the SOX very closely. For an up-to-date two-year comparison of the two, use this link.
The Philadelphia Semiconductor Index
The Philadelphia Semiconductor Index is a price-weighted index composed of 18 U.S. semiconductor and equipment companies primarily involved in the design, distribution, manufacture, and sale of semiconductors. The index was set to an initial value of 200 on Dec. 1, 1993 and was split two-for-one on July 24, 1995; options commenced trading on Sept. 7, 1994.
The Index was created by the Philadelphia Exchange, which trades more than 2,300 stocks, 780 equity options, 10 index options, and 100 currency pairs. The trading symbol for the Index is SOX. Options on the SOX are traded at Philadelphia (one point = $100). The contracts are settled in cash on the Saturday following the third Friday of the expiration month.
The SOX has a fairly strong weight to manufacturers of equipment for semiconductor manufacture (called semiconductor capital equipment manufacturers or semi caps). Consequently, the SOX is not typically a chip company index as is widely thought. For example, four equipment companies - KLA-Tencor, Novellus and Applied Materials (all semi cap manufacturing equipment) and Teradyne (which manufactures test equipment) – combined represent around 30 percent of the total weight of the SOX index. Semiconductor stocks included in the Index include those operating in the memory, analog, wireless, and power management sub-sectors as well as broadline semi companies.
Table 1: Composition of the SOX
Name of Company Symbol % Weight In SMH?
KLA Tencor Corp. KLAC 12.4 % Yes
Maxim Integ Products, Inc. MXIM 9.7 % Yes
Linear Technology Group LLTC 8.9 % Yes
Novellus Systems, Inc. NVLS 8.7 % Yes
National Semi Corp. NSM 6.2 % Yes
Xilinx, Inc. XLNX 5.7 % Yes
Intel Corp. INTC 5.7 % Yes
Broadcom, Inc. BRCM 5.7 % Yes
STMicroelectronics STM 5.1 % No
Altera Corp. KLAC 4.9 % Yes
Texas Instruments, Inc. TXN 4.9 % Yes
Applied Materials, Inc. AMAT 4.6 % Yes
Teradyne, Inc. TER 4.0 % Yes
Micron Technology Inc. MU 3.1 % Yes
Taiwan Semi Manufac. TSM 2.5 % No
LSI Logic Corp. LSI 2.5 % Yes
Motorola, Inc. MOT 2.3 % No
Advanced Micro Devices AMD 2.1 % Yes
The Semiconductor Holders Trust
The Semiconductor Holders Trust is a type of security called a HOLDR (see below). It was created by Merrill Lynch in cooperation with the American Stock Exchange (aka the AMEX) and is traded under the ticker symbol SMH on the AMEX. The SMH is comprised of 20 semiconductor and equipment stocks, compared with the SOX, which is comprised of 18. Among the group's more heavily weighted members are Intel (INTC), Texas Instruments (TXN), Applied Materials (AMAT) and Analog Devices (ADI).
An advantage of SMH is that an investor taking a longer-term (positive) view of semiconductor stocks can thus buy a composite semi stock in the SMH compared with the SOX, however, which can only be bought in the form of an option. Options also exist for the SMH.
The Semiconductor Holders Trust was formed pursuant to the depositary trust agreement, dated April 24, 2000. The Bank of New York is the Trustee. The Semiconductor Holders Trust is not a registered investment company under the Investment Company Act of 1940. The Trust is intended to hold deposited shares for the benefit of owners of Semiconductor Holders. The SMH is marginable, options on the SMH are available, and it can be short sold.
The specific share amounts for each round-lot of 100 Semiconductor Holders are set forth in the table below and were determined on 12/15/99 so that the initial weightings of each stock approximated the relative market capitalizations of the specified companies, subject to a maximum weight of 20%. The share amounts specified will not change except for changes due to corporate actions or reconstitution events.
Table 2: Composition of the SMH
Company Name Symbol # Shares % Weight In SOX?
Intel Corp INTC 30 21.2% Yes
Texas Inst Inc. TXN 22 16.3% Yes
Applied Materials Inc. AMAT 26 14.1% Yes
Analog Devices, Inc. ADI 6 7.2% Yes
Maxim Integ Prod Inc. MXIM 5 6.0% Yes
Xilinx, Inc. XLNX 5 4.8% Yes
Linear Tech Corp. LLTC 5 4.8% Yes
KLA-Tencor Corp. KLAC 3 4.0% Yes
Micron Tech Inc. MU 9 3.8% Yes
Altera Corp. ALTR 6 3.2% Yes
National Semi Corp. NSM 3 3.1% Yes
Broadcom Corp. BRCM 2 2.0% Yes
Teradyne, Inc. TER 3 1.7% Yes
Adv Micro Devices, Inc AMD 4 1.6% Yes
Novellus Systems Inc. NVLS 2 1.6% Yes
Atmel Corp. ATML 8 1.3% Yes
LSI Logic Corp. LSI 5 1.2% Yes
Amkor Technology Inc. AMKR 2 0.7% No
SanDisk Corp. SNDK 1 0.7% No
Vitesse Semi Corp. VTSS 3 0.6% No
The above table shows the trust component list as of 03/22/04. Download the current component list here.
What is a HOLDR (aka Holders Trust)?
A HOLDR is a type of security created by Merrill Lynch and traded on the American Stock Exchange. It bundles together a portfolio of stocks in a given sector, enabling investors to buy and sell the entire collection of stocks in a single transaction.
HOLDRS, such as the SMH, are trust-issued receipts that represent beneficial ownership of a specified group of stocks. In the case of the SMH, this is ownership of a group of stocks in the semiconductor and equipment sectors. Holders allow investors to get exposure to, and benefit from the ownership of, the stocks in a particular industry, sector, or group.
As I mentioned above, I typically use the SMH as an ETF (exchange traded fund) to get exposure to a group of large cap semi names. The ownership feature of Holders Trusts like the SMH has important benefits for investors:
Diversification. HOLDRS automatically provide investors with diversified exposure to an industry, sector or group of stocks – such as the semiconductor sector -- in a single investment. If an investor buys individual names, they would have to buy an equivalent number of different stocks to achieve the same level of diversification.
Personal control. With HOLDRS, investors can own a group of stocks as one asset, or unbundle them to own each of the underlying stocks. Then, they can trade the stocks individually to meet their tax or investment goals. This feature also facilitates more advanced portfolio strategies without requiring investors to monitor each of the individual stocks.
Tax advantages. HOLDRS have no hidden capital gains; investors owe taxes only on gains that they actually realize. If investors wish, HOLDRS allow them to take tax losses in any stocks that decline and to defer gains indefinitely on their best-performing stocks. The buy-and-hold feature of HOLDRS limits taxes that result from portfolio turnover.
Liquidity. HOLDRS are exchange-traded and are priced throughout the trading day just like any other stock.
Flexibility. HOLDRS can be used as a sector investment, an alternative to index funds, a starting point for long-term stock pickers, or as an inexpensive way to own a basket of stocks.
Lower costs. Investors don't have to pay management fees of any kind. Their only expense comes from transaction costs and from a small annual custody fee taken against cash dividends and distributions, when they are issued.
Ownership benefits. Investors retain the voting and dividend rights on the underlying stocks.
Exchange Traded Fund (ETF)
I mentioned above that I use the SMH as a kind of ETF. An Exchange Traded Fund is a fund that tracks an index, but can be traded like a stock. ETFs bundle together the securities that are included in an index. ETFs never track actively managed mutual fund portfolios because most actively managed funds only disclose their holdings a few times a year. So most of the time the ETF would not know when to adjust its holdings, and the percentage weights of its holdings within the basket.
The first ETF created was the Standard and Poor's Deposit Receipt (SPDR, pronounced "Spider") in 1993. SPDRs gave investors an easy way to track the S&P 500 without buying an index fund, and they soon become quite popular.
Investors can do just about anything with an ETF that they can do with a normal stock, such as short selling. ETFs are traded on stock exchanges, so they can be bought and sold at any time during the day (unlike most mutual funds). The price of ETFs will fluctuate from moment to moment, just like any stock's price. So, a negative of ETFs is that an investor needs a broker in order to purchase them, which means having to pay a commission. A positive, however, is that ETFs are more tax-efficient than normal mutual funds. In addition, since they track indexes they have very low operating and transaction costs associated with them. There are no sales loads or investment minimums required to purchase an ETF.
Melanie Hollands may hold a personal or professional position in the stocks she discusses. This article does not constitute a recommendation to buy or sell any security and is intended as "food for thought" only. For 14 years she has covered the technology and telecommunications sectors, from positions held in business strategy (McKinsey & Co., Bain & Co.), corporate finance (Salomon Smith Barney) and fundamental equity research (Merrill Lynch). She follows PC/server/storage hardware, enterprise and application software, wireless hardware/software/middleware, data networking and telecom equipment, optics, semiconductors, semi capital equipment, and various niche technologies (RFID, WiMax, VOIP and others). Hollands is president of Koala Capital (located in Aspen, Colo., and New York City), which focuses on trading/investing in technology stocks. She is also a senior advisory board member for a start-up financial services venture, the Semiconductor Futures Exchange Inc., and an advisory board member for a start-up Linux-HPC venture, Tadpole Ventures, LLC. She has been a guest lecturer and adjunct professor at Columbia Business School, where she earned her MBA, and also holds joint bachelor's degrees in Architecture and Structural Engineering. Ms. Hollands is unable to provide personalized investment advice.
For reference: Use this handy link to stock terminology.
Financial resources and subscription Web sites:
Bill Fleckenstein (www.fleckensteincapital.com) is President of Fleckenstein Capital, a Seattle-based hedge fund. Bill is a successful money-maker, has great insights, and calls it like he sees it -- there's never any doubt where Bill stands on anything market-related. He also writes a column "The Contrarian Chronicles" on MSNBC.
Richard Russell: www.dowtheoryletters.com.
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