What is a 'Semiconductor'

A semiconductor is a material product usually comprised of silicon, which conducts electricity more than an insulator, such as glass, but less than a pure conductor, such as copper or aluminum. Their conductivity and other properties can be altered with the introduction of impurities, called doping, to meet the specific needs of the electronic component in which it resides. Also known as semis, or chips, they can be found in thousands of products such as computers, smartphones, appliances, gaming hardware, and medical equipment.

BREAKING DOWN 'Semiconductor'

Semiconductor devices can display a range of useful properties such as showing variable resistance, passing current more easily in one direction than the other, and reacting to light and heat. Their actual function includes the amplification of signals, switching, and energy conversion. Therefore, they find widespread use in almost all industries and the companies that manufacture and test them are considered to be excellent indicators on the health of the overall economy.

Semiconductor makers often see "boom and bust" cycles based on the underlying demand for chip-based products. When times are good, profit margins can run very high for chipmakers; when demand falls through, however, chip prices can fall dramatically and have a major effect on many industries' supply chains.

Research and Development are Key

Success in the semiconductor industry depends on creating smaller, faster, and cheaper products. The benefit of being tiny is that more power can be placed on the same chip. The more transistors on a chip, the faster it can do its work. This creates fierce competition in the industry, and new technologies lower the cost of production per chip so that within a matter of months, the price of a new chip might fall 50%.

This gave rise to the observations called Moore's Law, which states that the number of transistors in a dense integrated circuit doubles approximately every two years. The observation is named after Gordon Moore, the co-founder of Fairchild Semiconductor and Intel, who wrote a paper describing it in 1965. After 1975 the doubling period is often quoted as 18 months because of Intel executive David House, who predicted that chip performance would double every 18 months.

As a result, there is constant pressure on chipmakers to come up with something better and even cheaper than what defined state-of-the-art only a few months before. Therefore, companies need to maintain large research and development budgets. The semiconductor market research association IC Insights reported that the largest 10 semiconductor companies spent an average of 13.0% of sales on R&D in 2017, ranging from 5.2% to 24.0% for individual companies.

Investing in the Semiconductors

Aside from investing in individual companies, there are several ways to monitor the investment performance of the sector. These include the benchmark PHLX Semiconductor Index, known as the SOX, as well as its derivative forms in exchange-traded funds. There are also indices that break the sector down to chip makers and chip equipment makers. The latter develops and sells machinery and other products used to design and test semiconductors.

In addition, certain markets overseas, such as Taiwan, South Korea, and to a lesser extent Japan, are highly dependent on semiconductors and therefore their indices also provide clues on the health of the global industry.

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