r/valueinvesting
The margins in semiconductors don’t seem sustainable
Questions sustainability of high semiconductor margins due to risks from AI efficiency gains, capacity expansion, and China competition.
- Continuous expansion of AI context windows drives steady demand for compute and memory.
- Unlocked capabilities at every step of compute demand growth sustain the current cycle.
- Current operating margins (50-70%) are historically unprecedented and likely to mean-revert.
- Risks include AI model efficiency breakthroughs, increased capacity, and Chinese competition.
- Any slowdown in big tech capex could cause a disproportionately large drop in margins.
Micron operating profit margins have expanded to about 50%, and they are forecast to go to something like 70%. The average over recent history has been in the 20-30% range.
SK Hynix is already at a 60% operating margin and is also forecast to go towards 70%.
Nvidia, which used to have a high 20% operating profit margin, has been coasting at a high 60% operating margin for some time now.
TSMC has always had pretty margins, in the high 30% range, but is now in the mid 50% operating margin and forecast to go towards 60% operating margin.
These margins all seem quite high by historical standards.
One big risk is a big efficiency breakthroughs in the models. This might improve capabilities without expanding compute as much, getting more bang for the buck.
Another is that there does seem to be more capacity coming, at least from the big memory chip companies. TSMC is expanding capacity at a slower pace.
A third is that China catches up in a meaningful way. There are dozens of GPU startups in China now and many memory chip makers as well. They don’t have to get as good as an SK Hynix at memory and certainly not as a good as Nvidia at GPUs to have an impact, as long as you can string enough of them together and and direct less intensive work towards it, it can have an impact on margins.
Finally, any slow down in capex expansion from one of the big model makers might lead to a disproportionately large move in margins.
From my read there has been this steady march higher of compute demand and more capabilities unlocked at every step.
In particular, it seems like it’s continued expansion of the context window that has enabled a lot of the big gains in AI functionality recently. The further expansions in the context window will mean more and more memory required.
But at some point do we get diminishing returns of expanding the context window? And at that point, what happens to the incremental demand for memory chips?
They aren't sustainable.
Once the data center demand an AI hype subsides, these margins will necessarily compress.
yep.
people have short memories. remember the "picks and shovels" of the dot com era? cisco, jds uniphase, corning, juniper, sun, emc, .... - all of them saw their stocks collapse by 90%+ and most of them never recovered ... and most of these companies had better moats then mu, sndk, and wdc.
Did these companies have a crazy run with high margins during the dot com era ?
Cisco had a forward P/E of around 10, same as a lot of the RAM/SSD makers today, funny thing about forward P/E is that it’s just a prediction not a fact….
Pretty much yes. It's not a perfect match but it's quite close. The biggest difference people harp about is the companies this time are profitable vs the early dot com companies not being profitable.
The issue with that argument is the picks and shovels in both cases were profitable. The attached businesses this time are profitable. The AI portion of the businesses however are not as a group profitable. Amazon without its AI business is profitable. Amazons AI business by itself is not. Same thing applies to Google and Microsoft. Meanwhile openAI isn't profitable. SpaceX isn't profitable.
Right now we are somewhere between 1998 and 2000 on the charts. There are big macro economic differences which might let this run go longer or bring it to a halt sooner but when this falls apart I won't be surprised if we plunge back to the long term trend line that was tapped in April 2025.
One thing to take into account is Jevon's paradox which is basically increased efficiency and reduced pricing increases demand.
People keep misunderstanding this. Jevon's paradox means increased total consumption, not increased demand. Demand will be falling at some point.
Consumption increases as supply increases and demand decreases. Demand is willingness to pay. Hyperscalers won't be willing to pay high prices forever, they will cut costs to become profitable, however the total consumption can increase if supply increases and price falls.
Great question and points you make. My personal take is that this will eventually end with oversupply, because the semiconductor supply chain is so complex and has such long lead times it's hard to have a soft landing.
But we don't know how many years it could take. A few observations:
\- We are currently supply constrained. That means there really are companies willing to buy up every bit of supply there is.
\- Apple just increased their prices. My sense is if this were short term, they would address the crunch differently.
\- Jevon's paradox has held here to date. Cheaper tokens means more use cases that AI is cost-effective for.
\- Nvidia has maintained gross margins of \~75% since late 2023.
\- A big difference from the dotcom buildout: unlike fiber, every bit of compute is getting used. There's evidence that even A100s and older chips are still being utilized, and prices to rent them have gone up.
All of this suggests this could go on a bit longer (it could also unwind without much warning). But one thing that could prolong this whole buildout more than anything else is TSMC's supply. It will take years to get enough advanced node compute online, which prevents the rest of the market from growing as fast as it could. Ben Thompson at Stratechery has written about this as TSMC providing a brake for growth of the rest of the market. The guys at SemiAnalysis have some good content on this whole buildout, both written and on YouTube.
Correct me if I'm wrong, but the fact that we're supply constrained means that the buyers in this market would actually like to buy even more, and growth would be even faster if it weren't constrained. It's hard to wrap one's head around this...
lasted a good 3 years before everyone woke up.
a few catalysts for the stock market collapse: (1) fed interest rate hikes cut off cheap money (mind you, fed funds rate was 5%+ back then, and it actually peaked at 6+% in may 2000, a couple of months after the stock market collapse began); (2) no more spending related to y2k (remember the world was going to end when the clock hit 1-1-00?; (3) the insiders at many of these companies knew the jig was up and started selling most of their positions; (4) many retail investors were also looking to sell in order to pay their tax bills for any long and short term capital gains they had incurred during the huge run up in 1999.
the AI boom has all the hallmarks of history repeating itself.
None of that is HBM which is structural now
At this point it’s just a transfer of wealth from hyperscalers to memory/infrastructure. Theres no broadening of downstream revenue base that cost can be passed down to. At what point does the money run out if all these chips depreciate and get replaced every 4yrs, which we are now already in a replacement cycle. The bull case is that these are necessary and they’ll keep paying whatever price forever, except until they don’t or can’t because they can’t forever burn billions each year on compute. This is worse than the telecom companies laying copper and fiber that went bust back in the 90s and 00s at least that was like a 20yr investment. But it won’t take that long before big money figures out hyperscalers can’t or wont foot the next trillion bill for depreciating consumables like chips/memory. Short term bullish but this could change in a quarter and it will be quick.
When it comes to China, I have a slightly different perspective.
Clearly, China is pouring all its resources into developing various semiconductor products and is striving to narrow the gap with Western (U.S., Taiwan, South Korea...) products.
However, it is highly likely that most of this output will be used to meet China’s own domestic demand rather than being exported to the global market. This applies to everything China produces, from DRAM and HBM to GPUs and AI boards. Since China is developing AI models and expanding its infrastructure to a level capable of competing with the U.S., it will likely need hundreds of billions of dollars’ worth of semiconductors.
I think the margin risk is real, but I’d frame it less as “AI demand goes away” and more as “the bottleneck eventually moves.”
Right now memory and advanced packaging still have pricing power because everyone is trying to buy the same scarce capacity at the same time. That never stays clean forever.
For me the signal is when customers stop begging for allocation and start negotiating again. That’s usually when the margin story changes.
Omg sell everything now!!!!