Sweet on Semiconductors
article 03-21-2023

Sweet on Semiconductors

Portfolio Managers Jim Stoeffel, Brendan Hartman, Jim Harvey, and Assistant Portfolio Manager Kavitha Venkatraman discuss why the semiconductors & semiconductor equipment industry has long been a staple in Royce Small-Cap Opportunity Fund.


Over most of its long history, Royce Small-Cap Opportunity Fund, the mutual find we manage in Royce’s Small-Cap Opportunistic Value Strategy, has had significant exposure to the Information Technology sector and, within it, the semiconductors & semiconductor equipment industry. The portfolio’s weightings in both areas have also been higher when our conviction is strongest than those in both its primary benchmark, the Russell 2000 Value Index, and its secondary benchmark, the Russell 2000 Index.

These higher weightings are a distinctive feature of the portfolio among actively managed small-cap value funds because so many other managers avoid making significant investments in Information Technology. However, the criteria we use across all sectors in this Strategy is squarely focused on helping us find inexpensive small- and micro-cap companies that we believe have strong growth prospects.

We typically begin the process by screening for companies with low price-to-book and price-to-sales ratios. From there, we apply our extensive knowledge of sector and industry dynamics to begin culling what we believe are the best ideas among an often lengthy list of potential portfolio candidates. Much of the team’s time is spent staying educated and up-to-date on business, industry, and sector cycles because we are not just looking for cheap stocks but also for companies with catalysts for growth.

“We believe that semiconductor testing will continue to grow faster than the overall semiconductor industry and hold two companies that specialize in testing whose long-term prospects we think are bright.” —Jim Stoeffel

Within semiconductors, we gravitate toward component makers and companies that provide testing services. Most are domestic enterprises that sell to larger, global manufacturers. While there are comparably few small-cap semiconductor makers, we also know those companies well. The industry functions today as a highly efficient oligopoly in our view, from the larger manufactures such as Taiwan Semiconductor, Nvidia, and Applied Materials to the smaller though well established companies that we consider. The importance of semiconductors has increased steadily over the last three-plus decades, and shows no signs of slowing down. Semis are ubiquitous; they are found in nearly every device we use, as well as in countless industrial applications. Their importance in areas such as Artificial Intelligence, 5G, automotive, consumer electronics, and the Internet of Things has altered the industry’s dynamics, giving semiconductors less of a boom-and-bust cyclical profile. The industry’s strong and usually steady growth has also helped spur a wave of consolidation over the last several years.

The shares of most semiconductor companies, regardless of market capitalization, were hit hard by lingering Covid-driven supply chain disruptions, which in 2022 saw the industry’s post-Covid rebound considerably derailed. We watched and waited for valuations for both new and existing holdings to fall into ranges that we found attractively inexpensive. With the reduction in earnings we have seen across the industry over the past couple of quarters, we have been finding a number of interesting investment opportunities that fit our Interrupted Earnings theme. We believe that the semiconductor industry is experiencing a normal cyclical earnings correction and expect that many of these companies will be shifting toward positive longer-term growth outlooks. More specifically, we also believe that semiconductor testing will continue to grow faster than the overall semiconductor industry and hold two companies that specialize in testing whose long-term prospects we think are bright.

Cohu provides back-end semiconductor testing and handling equipment. We became involved in the stocks after Cohu acquired Xcerra in 2018, which we viewed as a sound and complementary strategic acquisition. Within the context of our investment themes, we originally viewed the company as a turnaround as there were significant execution risks around integrating Xcerra, as well as the challenge of managing the debt Cohu took on to finance the acquisition. The company has successfully executed our original investment thesis, including several hundred points of gross margin improvement and significant debt reduction. Its shares began to recover in 4Q22, and we continue to like the stock, as Cohu has a very diverse set of end markets including nascent growth opportunities, such as testing semiconductors for EVs, and a high level of recurring revenues.

FormFactor designs, develops, manufactures, and supports precision, high performance advanced semiconductor wafer probe cards that is a leading provider of essential test and measurement technologies along the full integration circuit life cycle, from characterization, modeling, reliability, and design de-bug to qualification and production tests. We like FormFactor’s strong position in a duopoly market where it provides consumable products that are designed into its customers’ chip manufacturing processes. In contrast to Cohu, its shares have only recently begun to recover, thanks in part to solid fourth-quarter results in which FormFactor’s management noted improved demand from its foundry and logic customers, and signs of a trough in the forecast for demand in the semiconductor memory industry. We also think that the secular trends of increased complexity in chip manufacturing and packaging will continue to stoke the need for more test intensity and, by extension, demand for FormFactor’s probe cards.

Important Disclosure Information

Average Annual Total Returns as of 12/31/2022 (%)

NET               GROSS
Small-Cap Opportunity 12.35 -17.08 11.14 7.09 10.65 11.62 11/19/96  1.21  1.21
Russell 2000 Value
8.42 -14.48 4.70 4.13 8.48 8.72 N/A  N/A  N/A
Russell 2000
6.23 -20.44 3.10 4.13 9.01 7.84 N/A  N/A  N/A
1 Not annualized.

All performance information reflects past performance, is presented on a total return basis, reflects the reinvestment of distributions, and does not reflect the deduction of taxes that a shareholder would pay on fund distributions or the redemption of fund shares. Past performance is no guarantee of future results. Investment return and principal value of an investment will fluctuate, so that shares may be worth more or less than their original cost when redeemed. Shares redeemed within 30 days of purchase may be subject to a 1% redemption fee, payable to the Fund which is not reflected in the performance shown above; if it were, performance would be lower. Current month-end performance may be higher or lower than performance quoted and may be obtained at www.royceinvest.com. Operating expenses reflect the Fund's total annual operating expenses for the Investment Class as of the Fund's most current prospectus and include management fees and other expenses.

Mr. Stoeffel’s, Mr. Hartman’s, Mr. Harvey’s, and Ms. Venkatraman’s thoughts and opinions concerning the stock market are solely their own and, of course, there can be no assurance with regard to future market movements. No assurance can be given that the past performance trends as outlined above will continue in the future.

Percentage of Fund Holdings As of 12/31/22 (%)

  Small-Cap Opportunity





Taiwan Semiconductor




Applied Materials


Company examples are for illustrative purposes only. This does not constitute a recommendation to buy or sell any stock. There can be no assurance that the securities mentioned in this piece will be included in any Fund’s portfolio in the future.

The performance data and trends outlined in this presentation are presented for illustrative purposes only. Past performance is no guarantee of future results. Historical market trends are not necessarily indicative of future market movements.

Sector weightings are determined using the Global Industry Classification Standard ("GICS"). GICS was developed by, and is the exclusive property of, Standard & Poor's Financial Services LLC ("S&P") and MSCI Inc. ("MSCI"). GICS is the trademark of S&P and MSCI. "Global Industry Classification Standard (GICS)" and "GICS Direct" are service marks of S&P and MSCI.

Frank Russell Company (“Russell”) is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and / or Russell ratings or underlying data and no party may rely on any Russell Indexes and / or Russell ratings and / or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell’s express written consent. Russell does not promote, sponsor or endorse the content of this communication. The Russell 2000 is an unmanaged, capitalization-weighted index of domestic small-cap stocks. It measures the performance of the 2,000 smallest publicly traded U.S. companies in the Russell 3000 index. The Russell 2000 Value and Growth indexes consist of the respective value and growth stocks within the Russell 2000 as determined by Russell Investments. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

This material is not authorized for distribution unless preceded or accompanied by a current prospectus. Please read the prospectus carefully before investing or sending money. Smaller-cap stocks may involve considerably more risk than larger-cap stocks. (Please see "Primary Risks for Fund Investors" in the prospectus.) The Fund’s broadly diversified portfolio does not ensure a profit or guarantee against loss.



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