My Review* of Chris Miller's "Chip War: The Fight for the World's Most Critical Technology"

 Chips: The New Oil

 

Tufts professor Chris Miller makes a strong case that computer chips have become to the 21st century what oil was to the 20th century in terms of global politics. Computer chips are now ubiquitous and have uncountable applications in industry, consumer products and military hardware. We found that out when pandemic related supply shortages shut down production in a host of industries.

 

Miller plows over old ground with his discussion of the invention of the transistor at Bell Labs in 1947 to the co-invention of the integrated circuit in 1956 by Jack Kilby at Texas Instruments and Bob Noyce who would go on to lead Intel. He then goes on to discuss the “traitorous eight” who bail out of Fairchild Semiconductor in 1968 to for what was to become the Intel behemoth. They all wanted to get rich.

 

The government plays a major role in supporting the industry. The need to reduce the weight of the Minuteman missile sent the Pentagon scurrying to buy integrated circuits from Texas Instruments. As the Cold War heats up more and more integrated circuits find their way into military hardware. I remember in 1967 when I was working for Litton Industries, I first noticed integrated circuits appearing in airborne guidance and control systems.

 

Not mentioned in the book, Texas Instruments benefited from the Kennedy/Johnson White Houses sending defense contracts to Texas and New England. Silicon Valley in California was left out in the cold, but more than compensated by going after the lucrative civilian market. 

 

To me most interesting was the role of Texas Instruments engineer Morris Chang who invented chip production processes. When he was passed over to be president of the company he moves to Taiwan and is instrumental in establishing Taiwan Semiconductor, now the largest manufacturer of chips in the world. Who knows what would have become of Texas Instruments if he became its president.

 

It is Morris Chang who makes Taiwan a semiconductor powerhouse and that is the reason why most of the world’s chips are made there today. Being located 100 miles from China is not exactly the safest place in world to manufacture this critical commodity. It is for this reason there now is a move to diversify production to other sources including the huge U.S. government subsidies now being funneled into the domestic chip industry.

 

Because both the Russians and the Chinese understand how critical computer chips they established their own industries. The Russians did what they do best which was to copy the west, but with the technology advancing so quickly that became a failing strategy. China, on the other hand, is making a huge investment in their own chip industry to wean their economy’s dependence on western made chips and equipment. In case of the latter there was a story today where Chinese spies obtained secrets from ASML, the Dutch monopoly supplier of extreme ultraviolet lithography equipment. Their machines are essential in the manufacture of chips and cost $100 million apiece.

 

The saddest part of the book is Miller recounting the decline of Intel. It seems the bean counters took over from the engineers. In 2008 Intel turned down Steve Jobs’ offer to them to make chips for the I-Phone ceding the market to Qualcomm. Thus, Intel was nowhere in communication chips and it is being rapidly displaced in the server market by graphics processing chips being made by NVIDIA and AMD.

 

Miller’s book reads like a fast-paced business thriller. There are great anecdotes and reader will learn much about what will shape geopolitics this decade and beyond.

*-Amazon has yet to post this review. The review was just posted 2:23MST at            Chips: The New Oil (amazon.com) 

 

The Defanging of the Stock Market

 

April has brought with it the defanging of the stock market where the hitherto invulnerable FAANG stocks crashed and burned bringing with it a full-fledged bear market in the NASDAQ Composite Index. FAANG stands for Facebook (now Meta Platforms) Apple, Amazon, Netflix, and Google (now Alphabet). From their respective 52-week highs Meta is down 48%, Apple is down 13%, Amazon is down 33%, Netflix is down an astounding 73% and Alphabet is down 23%. Taken as a whole the NASDAQ Composite is down 23%. The weakness in these five stocks which at one time accounted for nearly a quarter of the market value of the S&P 500 brought that benchmark index down 14%.

 

Market behavior of this type is reminiscent of the 1973-74 and the 2000-02 bear markets. In the 1970s the so-called Nifty-50 group of one-decision growth stocks which were trading at 50-60X earnings experienced declines in excess of 50 -80% during the course of the bear market. In the collapse of the 2000 dot.com bubble such stalwarts as Cisco, Microsoft, Intel, and Oracle (a group of stocks that I then characterized as “The Four Horseman of the NASDAQ”) which traded at multiples in the 80-100X range lost about three quarters of their market value. Indeed, just as today, the stock market was bracing for a tightening of monetary policy. Needless to say, the history is not encouraging.

 

There are, however, two distinct differences between then and now. First, from 1972-74 the 10-year Treasury traded in a 6-8% range and in 2000-02 it traded in a 5-6% range far higher than the current 2.9% yield. Second, with the exception of Netflix valuations are nowhere near as demanding with Alphabet trading less than 20X earnings, Apple at around 25X, Meta at a below market 14X earnings. As a result, even if Treasury yields rise to 4%, my sense is that the worst of the declines in FAANG and the market as whole are behind us.

 

To be sure, we could soon be looking into the teeth of a recession triggered by a very aggressive Fed and continued high inflation which would haircut earnings estimates across the entire market. We are sure to have a recession at some point, but I do not believe it is soon. Simply put the end of the pandemic is fueling a consumer boom and capex remains strong fueled technology and energy related spending of all types. Thus, it will take more than 250 basis points of tightening to break this economy. Of course, if we are in a rerun of “That 70’s Show,” all bets are off. (Shulmaven: Roaring 20's or That 70's Show)

 

As I wrote in February(https://shulmaven.blogspot.com/2022/02/the-unravelling.html), my sense is that we are in a structural bear market in bonds and in for a very volatile stock market. Whether or not the lows are in or not, I do not know, but the world will not look as bad in December as market participants feared last week. Net, net although 2022 will be a down year for stocks, the market will end the year higher than where it is now.

My Amazon Review of Bruce Greenwald's et.al. "Value Investing: From Graham to Buffett and Beyond" 2nd. Ed.

 

In Search of Value

 

As a value investor, I have the highest respect for Bruce Greenwald and his colleagues. Unfortunately, in recent years value investing has failed to live up to its billing. Indeed, over the past two decades Warren Buffett’s Berkshire Hathaway has performed roughly inline with the S&P 500. (I am a shareholder.) My history with value investing goes back to reading Graham & Dodd in 1964 while attending Baruch College. Further I own the classic 1940 edition of that book and Greenwald’s first edition of this book. Nevertheless, I did find my way to owning Microsoft, Apple, and Alphabet.

 

Nevertheless, Greenwald’s new book is worth a careful read. He is very wise in dismissing modern portfolio theory’s Beta as a measure of risk. Why? The beta measure of risk is independent of stock price. He is also very cautious about using discounted cash flow over long periods of time because the results are extremely sensitive to small changes in the discount and growth rates.

 

Greenwald plows over old ground in his discussion using net reproducible assets and earning power as a method for determining value. He then goes one step further by introducing franchise value into his valuation paradigm. Simply put franchise value is created by the ability of a firm to earn significantly higher returns over its cost of capital over a sustained period. Those returns arise from the existence of a protective “moat” around its businesses. Greenwald also recognizes that over time a firm’s franchise value can decline, and he thus introduces a decay factor to account for this factor.

 

The question arises is why hasn’t value investing been successful in recent years. There are at least two explanations. First is that the economy has shifted from tangible asset based to intangible asset based. That means GAAP accounting does not put on the balance sheet such intangibles as trademarks, patents organizational efficiency and research and development platforms. Greenwald adjusts for these factors, but there is higher error term surrounding the valuation of intangibles than tangibles. Second the Fed’s zero interest rate policy coupled with quantitative easing has likely distorted many of the historical metrics defining value.

 

The book was written before Berkshire Hathaway made its $735 million investment in Snowflake, a cloud computing software company. At Berkshire’s price, the company was valued at $34 billion and had trailing twelve months revenue of just under $500 million. Whatever one can say it is hard to make a valuation case for this company. Nevertheless, the stock more than doubled after Berkshire’s IPO purchase.

 

Greenwald has a very long discussion about Intel, the semiconductor giant, which at times in its history represented true value. He blames Intel’s recent problems on value destroying acquisitions. That is true in part, but Intel’s real problems run deeper. Its franchise value has deteriorated as it vaunted R&D operation failed to keep up with advances made by Applied Micro Devices, Nvidia and Apple. Moreover, its edge in manufacturing disappeared as Samsung and Taiwan Semiconductor surpassed it in the production of the latest generation of chips. In other words, Intel’s “moat” was paved over by competition despite its spending 19% and 22% of revenue on R&D and capital spending in 2019, respectively.

 

An added attraction of the book is that it includes vignettes from star value investors as Warren Buffett, Mario Gabelli, and Seth Klarman, among others. I read the book in the Kindle version; given the number of tables, it would have been an easier read in the hardback version.

 

Lastly, I recently started a position in a stock that currently trades at 10 times earnings and is trading at or below in my estimate, the reproduction costs of its assets. So, hope springs eternal and I will close with the opening quote that Graham & Dodd used in their classic text “Security Analysis: Principles and Technique,” from Horace’s Ars Poetica, “Many shall be restored that now are fallen and many Shall fall that now are in honor.”

For the full Amazon URL see: In Search of Value (amazon.com)