We recently compiled a list of the 10 Small Publicly Traded Semiconductor Companies To Buy. In this article, we are going to take a look at where AXT, Inc. (NASDAQ:AXTI) stands against the other small publicly traded semiconductor stocks.

The semiconductor industry has become one of the most important in the world, akin to the key role that oil plays in the global economy. While making this argument would have been tricky in 2022, 2023 and the onset of the artificial intelligence boom makes it much easier to say so. This is because chip companies sit right at the heart of the AI revolution due to their ability to transform literal sand on a beach into pieces of silicon that aim to meet or surpass human intelligence.

This criticality of semiconductors to the global economy and AI has translated into share price performance as well. Wall Street, always eager to catch the next big trend before it occurs, has piled into semiconductor stocks with no end in sight. Some of the biggest semiconductor firms in the world are up by 211% over the past twelve months, and their share price performance is matched by equally impressive revenue growth which would have been thought to be impossible just a couple of years back.

Semiconductor stock indexes which are made of the most consequential chip firms in the world have also gained value. Semiconductor stock indexes, maintained by the S&P and the Philadelphia Stock Exchange are up 17.26% and 57.94% respectively over the past twelve months. This burst of performance comes after a disastrous 2022 that saw big and small semiconductor stocks tumble in the wake of a historic demand and supply mismatch following the coronavirus pandemic. The semiconductor sector is highly cyclical, and between the start of 2022 and the market bottom in October, the S&P’s semiconductor stock index had lost 42% while Philly’s index was down by 43%.

When it comes to valuing semiconductor stocks, some investors prefer to use the price to earnings growth (PEG) ratio instead of the more popular price to earnings (P/E) ratio. The PEG ratio also accounts for earnings growth, and when we look at some fast growing semiconductor stocks with vastly different market capitalization and revenue base, the ratio hovers around 1.45 to 1.48 for both of them. This ratio can inform investors about the future trend of a firm’s stock based on its historic EPS growth to see whether there is an earnings growth trend that can be exploited.

As for investing in semiconductor stocks, some research shows that it might be worth it. One such paper comes from researchers in China who used a benchmark portfolio of US listed semiconductor stocks on the NASDAQ and NYSE with an enterprise value greater than $50 billion and generated a forecast portfolio using the free cash flow to the firm (FCFF) model to check whether future cash flows merit a current investment. Their study revealed that not only was the benchmark portfolio undervalued by 30.56%, but it had an even higher undervaluation of 37.29% when the P/E ratio was analyzed. Of course, the cutoff date for the research was April 2023, so some of the growth predicted in this model has already materialized by now.

Finally, before we head to our list of the top small publicly traded semiconductor companies, it’s also important to see what experts think about the future direction of the industry. Research from Gartner shows that global semiconductor revenue will grow by 17% in 2024 to sit at $628 billion, with the growth fueled by a whopping 66% growth in the memory industry. The product end of the semiconductor industry is broadly bifurcated into application processors (such as CPUs and GPUs) and memory products (such as RAM), and often, different firms dominate either area. The 17% Gartner growth estimate is matched by a 16% growth estimate from the World Semiconductor Trade Statistics (WSTS). McKinsey estimates that global semiconductor sales will reach $1 trillion by 2030.

Currently around two thirds of global semiconductor sales take place in Asia. About 75% of global wafer fabrication capacity is in 4 Asian countries: Taiwan, South Korea, China, and Japan. In August 2022, President Biden signed into law the CHIPS and Science Act of 2022, providing $39 billion in incentives over 5 years to bolster semiconductor manufacturing in the US. Overall, the semiconductor industry is very active both on the demand side and the supply side. There are some signs that this industry might be in bubble territory. According to Aswath Damodaran, semiconductor industry contains 63 firms and these firms have an average EV/EBITDA ratio of 31.6. This is the highest EV/EBITDA multiple among all industries tracked by Damodaran (only positive EBITDA firms are considered for these calculations).

With these details in mind, let’s take a look at some small publicly traded semiconductor companies. As compared to the giants, there might be greater growth runways to these firms, allowing the prescient investor to capitalize early on.

Our Methodology

To make our list of the top small publicly traded semiconductor companies, we ranked semiconductor and semiconductor equipment stocks with a market cap lower than $2 billion by the number of hedge funds that had bought the shares in Q1 2024. Out of these, the top stocks were chosen.

Why are we interested in the stocks that hedge funds pile into? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points (see more details here).

AXT, Inc. (NASDAQ:AXTI)

Number of Hedge Fund Investors In Q1 2024: 19

AXT, Inc. (NASDAQ:AXTI) is a key backend semiconductor equipment provider since it provides substrates that chip manufacturers use to print the circuits on and make the end product. A diversified firm, its products are used in data centers, power management, communications, solar, and autonomous applications. This means that AXT, Inc. (NASDAQ:AXTI) remains insulated from a downturn in one industry provided that other sectors continue to perform well. Its two key products are based on Indium and Gallium phosphides, and both are used to manufacture key products for AI and satellites. This means that as the demand for AI products grows, AXT, Inc. (NASDAQ:AXTI) might benefit since its products enable AI servers to transfer data at high speeds – a non negotiable component of an AI data center’s performance.

These trends appear to be already playing out in the market as AXT, Inc. (NASDAQ:AXTI)’s management share during its latest earnings call:

We review AI as an exciting catalyst for Indium phosphide in the years to come. As AI requires high-speed lasers and detectors for rapid data transfer with increased bandwidth, low attenuation and low distortion. Today, AI applications are primarily oxide pixels, which require a relatively small amount of substrate material. But as the industry moves to 800 gig and then 1.6 terabyte speed, we expect that there will be a necessary transition to indium phosphide. We are already seeing development work happening today with next-generation silicon photonics devices and electro-absorption modulated laser or EML for high-speed data center transceivers. Revenue from these applications contributed to our strong indium phosphide growth in Q1 and will help drive our expected growth in 2024.

Our gallium phosphide revenue grew 24% sequentially in Q1, reflecting increased demand across a broad base of applications, including power amplifiers, HPT applications for wireless our switches, high-power lasers and LEDs. We believe much of the excess inventory in the supply chain has been decided, and we are benefiting from a desire among our customers to diversify their supply base as the market recovers. For example, today, our share of the HPT market is relatively small, but we believe we have a great opportunity to increase our market share over time and are pleased with early customer traction. In addition, our 8-inch gallium site development efforts have led to a groundbreaking advancements in both of our defect densities and yields.

Overall AXTI ranks 7th on our list of the best small publicly traded semiconductor stocks to buy. You can visit 10 Small Publicly Traded Semiconductor Companies To Buy to see the other semiconductor stocks that are on hedge funds’ radar. While we acknowledge the potential of AXTI as an investment, our conviction lies in the belief that AI stocks hold greater promise for delivering higher returns, and doing so within a shorter timeframe. If you are looking for an AI stock that is more promising than AXTI but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.

READ NEXT: Analyst Sees a New $25 Billion “Opportunity” for NVIDIA and Jim Cramer is Recommending These 10 Stocks in June.

Disclosure: None. This article is originally published at Insider Monkey.