Semiconductors. Semis. Microchips. For the busy among us, just “chips.” These are some of the most common names you’ll hear in lieu of the syllable-heavy “semiconductors” to describe the miracle of innovation that powers our planes, computers, smartphones, gaming hardware, medical equipment, TV, fridge, coffee machine, camera, LED bulbs, washer and dryer…and even your toaster. (And if that seems like a long list, that’s just the tip of the iceberg.)

🤔 Understanding semiconductors

In the scientific world, semiconductors are materials that conduct current – partly (hence the name). In particular, the tech sector uses silicon – which conducts electricity better than glass, but worse than copper – to produce semiconductive chips that take on essential roles in electronic circuits and devices.

By altering the silicon with impurities (other metals or chemicals) in a method called “doping,” manufacturers can produce chips that meet specific needs for the electronics in which it resides – for instance, by changing the conductivity of the chip, how the chip converts energy, or in which direction the energy flows.

Semiconductors do this by way of their transistors, or binary switches, billions of which are packed into the space of a dime. The creation process is incredibly time-intensive – it can take up to four months just to produce a single chip. And uniquely, the process requires the lack of a human touch, as the production line is comprised entirely of specially calibrated robots from start to finish.

In short, there are four types of chips produced on these lines:

• Microprocessors, or central processing units (CPUs), contain the basic logic to perform tasks
• Memory chips temporarily store data as it passes to and from a computer’s brains
• Commodity integrated circuits, or standard chips, fulfill routine processing purposes (and are usually produced in huge batches by predominantly Asian-based manufacturers)
• Complex SOCs, or “systems on a chip,” are all about creating an integrated circuit chip that contains an entire system’s capabilities

Each of these chips serves a vastly different purpose, and most technologies require specialized versions to perform essential tasks. As such, the semiconductor design and manufacturing industry is incredibly competitive – and at the same time, full of niche players that service a handful of companies or products.

There are three main types of firms in the semiconductor industry:

• Integrated device manufacturers, or IDMs, are companies that both design and produce their own chips – while these used to be the norm, many in the industry have outsourced one half or the other to maximize profits and streamline their process
• Designers are “fabless” firms that focusing on drawing up new chips for other companies
• Foundries are manufacturers that actually produce chips

Success in the semiconductor industry depends upon three factors: making chips smaller, faster, and cheaper. Tiny chips with greater numbers of transistors hold more power and work more efficiently, which makes them better at their respective jobs.

Thus, competition in the industry is all about producing chips as quickly and cheaply as possible – and innovating technology to make that happen. As a result, the industry is so fiercely efficient that new technologies to lower the cost of production spring up in just months, which can lower the price of even brand-new chips by half.

What this means for you

If ever there was a time to invest in the semiconductor industry…well, frankly, that was when the market crashed in 2020. But if you’re ready to hop aboard now, you can get started investing in individual companies at every step in the supply chain process, as well as funds that capitalize on various segments of the sector.

For instance, you may choose to invest in the iShares PHLX Semiconductor ETF, which tracks the PHLX Semiconductor Index, the benchmark for the semiconductor industry.

Alternatively, the Invesco Dynamic Semiconductors ETF tracks only U.S.-based small- and mid-cap funds; while the First Trust Nasdaq Semiconductor ETF tracks only liquid semiconductor companies with an emphasis on growth; and the VanEck Vectors Semiconductor ETF tracks 25 semiconductor chip companies around the globe.

Wherever you choose to invest, remember that the sector is highly cyclical, based on boom-and-bust cycles driven by underlying demand. When demand is high, profit margins skyrocket – and when the bottom falls out of the market, chip prices fall and domino down the supply chain.

And because semiconductor companies fund massive research and development budgets, their expenses may ultimately cut into your potential profits…even if the chips they create don’t pay off in the end.