Stock of the week: The green trading theme that could dominate in 2022
The COP 26 summit has ended, albeit not without controversy. There was a last-minute glitch, where China and India watered down the wording of the global commitment to stave off the dangerous effects of climate change. However, minds are more focussed than ever to try and limit global warming to 1.5 degrees Celsius. Although many believe that the commitments reached at Cop 26 do not go far enough to limit global warming, the agreement is ground-breaking, as it is the first international agreement to phase down the use of coal, the dirtiest fossil fuel, and it is a roadmap to meeting the 1.5 Celsius target on global warming. There is still a huge amount of work to do to protect our planet from the devastating effects of climate change, and this will be played out in the investment world in the weeks and months ahead. In fact, we think that ESG investing, Environmental, Social and Green, will continue to be one of the biggest investment themes in 2022.
ESG: the future of investing
The rise of sustainable investing has been extraordinary. According to Morningstar, there is a total of $330bn in ESG funds as of September 2021, with $15.7bn flowing into ESG funds in Q3. This theme is becoming increasingly important to the investment community and to financial markets, and investment bank Goldman Sachs believes that strong flow momentum will continue into 2022 and beyond. The problem for traders is that ESG is a huge area, that encompasses many thousands of stocks. If you want to trade this theme yourself and not rely on ESG funds, then how do you know what to trade? We think that one sector really stands out: semi-conductors.
The “green-enablers” you need to know about
Semi-conductors are a unifying product in the green investing space because they are vital components for electric vehicles, energy efficiency efforts and the renewable energy sector. Due to this, there is a push to increase the weighting of semi-conductors in ESG funds, which could help semi-conductor companies’ share prices to perform well in the medium and long term. Semi-conductors have been called the “green enablers” by analysts at Goldman Sachs, and this is an investment trend that we can get on board with. It is worth remembering that semi-conductor companies manufacture chips and related components, and as such their business is cyclical just like any other manufacturing business. For example, sales volumes can ebb and flow, there is a degree of uncertainty around demand at any one time and the stock prices can be volatile. However, we think that global efforts to reduce our dependence on carbon and come up with other technologies will help demand at semi-conductor companies to remain strong, and this is why we think that investing in these building blocks of green technology could be profitable for the long term.
When choosing which semi-conductor company to buy, it can be useful to look at the following:
Research and development: this is why we like Nvidia and the Taiwan Semi-Conductor Manufacturing Company. Nvidia, the US semi-conductor giant, uses its strong profit gains to invest in research and develop new products. It spread its wings to enter the cloud computing market, and is using its technology for AI, machine learning and even self-driving cars. It is hoping to buy UK chip maker ARM, however, this is coming up against regulatory roadblocks. However, it is still using some aspects of ARM technology to build modern data centres and compete in this sector against the likes of Intel. TSCM is also investing in research to help with the likes of smart technology and industrial automation, which are also important to the ESG investing world.
Strong Balance sheets: Manufacturing is expensive, so it’s worth comparing debt levels to operating profits and cash at hand. Even if a company has a high debt load, which manufacturing companies often have, it does not matter as long as there is plenty of cash to pay down the debt and to pay interest payments etc, even if the market takes a dip.
Revenues: When you invest in a cyclical sector like semi-conductors, then you want to look for companies that have a decent history of sales growth. Added to this, chip-making has become a very competitive space in recent years, thus it is important to choose a company that has diversified revenue courses, which is another reason why we like Nvidia and TSCM.
We are fans of Nvidia, one of the best-known US semi-conductor companies, due to the fact that it ticks all of the boxes above. However, as you can see, its share price has surged this year, most likely due to its size and the fact that is almost a household name at this stage. This is why we also like NYSE-listed stock, Taiwan Semi-Conductor Manufacturing Company (TSCM), which analysts believe could see double-digit revenue growth for the next three years. The reason they expect such strong growth is that it has technology that will be needed for smart tech, industrial automation and the overall digitalisation of our lives that has surged since the Covid pandemic. Thus, we could see some of Nvidia’s rivals, such as TSCM, play catch up with the US behemoth in the coming year. We still think that there could be more upside to come for Nvidia’s share price as it is a leader in this sector. Overall, we believe that the green investing theme will continue to gather strength, that supply chain problems that have hit the semi-conductor sector are due to exceptional demand factors and not a fundamental problem with supply, and even if the overall stock market slows down in the US in the coming weeks, semi-conductor firms can still do well.