If Ray Dalio took profits here, then this stock needs to catch up

Key Points

• The semiconductor space may have squeezed out all its potential gains, or so Ray Dalio seems to show.
• Among the many winners, one name is looking to catch up in its financials, and management has the right plan to make this a reality.
• Analysts agree and have rewarded the stock with the only upside left in the peer group.

If there is one thing that investors need help getting used to, it is learning where - and where not - to take cues for potentially better places to invest when they come up. Many "experts" are fighting for eyeballs, recommending this stock and that trade, only to face hoards of dissatisfied customers who lost money.

For this and many other reasons, it could be wise to listen to the investors who don't get paid to advertise what they are buying and selling. The ones who make their money by investing for themselves and potentially for their clients as well. One such investor is Ray Dalio, the founder of Bridgewater Associates, the biggest hedge fund in the world.

Dalio and Bridgewater have been decreasing their position in Broadcom NASDAQ: AVGO after the stock reached new 52-week highs. The selling could be just some profit-taking to rebalance his portfolio or a change in sentiment toward the sector. Whichever it is, stocks like Micron Technology NASDAQ: MU have some catching up to do.

What's the market?

Looking at the family tree of semiconductor stocks can be an excellent way to begin answering the question of what the market is doing about the recent rallies in the space. However, to understand the future, you must understand a bit of the past. So here it is:

During the peak effects of the COVID-19 pandemic, there were shortages in all the necessary raw materials to make semiconductors. Since many industries rely on chips and semiconductors to function, these shortages caused bottlenecks and delays in nearly every sector of the economy. 

Bringing you back to economics class, what happens when a lot of people are after too much of the same product? The price of the desired product goes up. Now add to that dynamic that inventories for this product are in tight supply, making it hard to fulfill these added orders and guess what comes next. If you thought inflation, congratulations, here's a gift.

Profit margins jumped to new highs throughout the space as pricing power allowed all companies to boom past analyst expectations. This trend has lasted through much of 2023. So now that you are all caught up, here's what's happening.

Inventory levels across the industry have been rising now that all of the previous orders have been fulfilled. The problem is that bottlenecking demand is less fierce than during 2020-2021. Knowing what you know now and applying the opposite law of economics, what do you think will happen to margins?

That's right, losses in pricing power will potentially drive margins lower for most of these firms, a trend that has already reared its ugly head in recent quarters for some of these names. However, Micron is immune, or rather, the company is in a completely different position.

Difference maker 

On a quarterly basis, stocks like Advanced Micro Devices NASDAQ: AMD show a decrease in gross margins, driven by rising revenue costs and other sales price dynamics. Specifically for Advanced Micro Devices, the rate went from 49.5% in the second quarter of 2023 to 47.4% in the third quarter. It's not huge, but it's a sign of the times.

For Broadcom, the story follows along the same lines, with second quarter 2023 gross margins going from 69.4% down to 68.9%, a smaller rate of decline but another sign of the shifting tides in the semiconductor space.

Now for a contrasting measure and the difference maker in the industry, Micron. Though still not net positive, gross margins rose from negative 17.8% to negative 10.8%, nearly double the improvements in the cost of goods! 

So why would markets reward a stock with negative margins? Well, the earnings presentation lays out one of the reasons behind it. Within it, management speaks to their plans of keeping supply below the expected demand for DRAM and NAND chips and keeping a tight inventory coming into 2024 as well.

Assuming management can pull this off, the earnings expansion that will be created can be enough to send this stock flying more than it already has! And allow its financials to catch up to the rest of the pack. These assumptions are already being built into analyst price targets.

You see, Broadcom stock price targets land on $944.70 a share, 16.1% lower than where the stock trades today. For Advanced Micro Devices, a $137.40 price target also shows nearly a 6% downside from today's prices, which could have been better choices to begin with.

For Micron, a price target of $91.60 (which keeps getting boosted) will bring a 5.7% upside for a change in the industry trend. All the more reason to think that this stock still could have some potential catching up to do.