Silicon Insider: Why Chips Still Rule

There's a reason they call it Silicon Valley.

There are two basic truths about the world of high tech:

1) Before and after everything, it is always about the chips; and

2) Everybody forgets that fact.

You see, chips haven't been sexy in a long time. Microprocessors excepted, the semiconductor industry hasn't really been exciting since the mid-Sixties.

That's when the wild young men of Fairchild ran the hottest company on Earth, drank too much, got rich, crashed the company, and then ran off to found more than one hundred new chip companies … and create the modern Valley.

These "Fairchildren" were the men who founded Intel, National Semiconductor, AMD and the others. But though many went on to immense wealth and considerable honors, their days as pop stars were over by the mid-Seventies. They were supplanted by a new generation: PC revolutionaries such as Jobs and Wozniak, and video game pioneer Nolan Bushnell.

Since then, tech has enjoyed at least a half-dozen other celebrated groups of entrepreneurs, each corresponding to a hot new electronics industry, from workstations to Web sites. Each has been heralded as the Next Big Thing, and has experienced a meteoric rise and an equally precipitous crash.

The most recent of these, of course, was the dot-com bubble. The Valley became so synonymous with e-commerce that more than one commentator asked if the "Silicon" in the title was obsolete.

But Valley veterans knew better: they understood that the dot-com boom, like all the ones before it, only reconfirmed the pre-eminence of chips.

Moore's Law and the Binary Chip Economy

I once wrote that if, in 1965, you had wanted to predict what the U.S. would look like at the turn of the Millennium, the best indicator would not have been demographics, social patterns, cycles of history or the prognostications of the leading futurists — but rather Moore's Law on the development of semiconductors.

Once you understood the implications of chip power doubling every 18-24 months, you would have realized we were in for some kind of wild economic ride.

Research by a journalist friend of mine, Ed Clendaniel (see Web link, right), shows the reality even more starkly.

What you see is an industry that operates in a manner almost as binary as the products it builds. The chip biz, it seems, is nearly always either all-the-way on or all-the-way off, swinging seemingly overnight from annual growth rates of 20-50 percent all the way down to -15 percent or worse. This pattern, tracking the vitality of the U.S. economy, has held now for at least twenty years.

Further, given the latest breakthroughs in semiconductor design technology, Moore's Law is likely to continue to define modern life for at least another decade, perhaps two. And because of that, there is no reason to doubt that this binary pattern of the chip business won't continue as well.

Chip Industry as Economic Indicator

So what does all this mean? Two things:

First, chips not only drive the economy, but superbly reflect the business cycle.

They drive the economy because in the modern world, most real growth — in new companies, in new revenues sources, and most of all in new jobs — comes from innovation and the creation of new small companies.

Each new chip generation, arriving every couple years, presents huge new opportunities for new products, new companies and new markets … and a new economic boom.

Because it is so tightly bound to this new business creation, the chip industry not only feels the arrival of the next boom before almost anyone else, but more acutely. Thus, it is a terrific indicator: Where other economic indicators may present mixed signals until the expansion or recession is well underway, the chip industry is either pedal to the firewall, or in a full-lock powerslide. There ain't much ambiguity.

That suggests that the smart market watcher should always keep a close eye on the book-to-bill ratio of the semiconductor industry. These days, by the way, the industry arrow is pointing straight up.

A Long-Term Play Hard to Surpass

Second, silicon is gold.

Despite the roller coaster ride the chip industry has undergone over the last quarter-century, according to Clendaniel's numbers the average annual growth rate of the industry has been 12 percent — a number pretty much reflected in the stock prices of industry's major companies..

Apply a little compound interest to that figure and you get some jaw-dropping results. For example, had an investor bought 100 shares of Intel at its IPO in 1971, for a total of $2,350, his or her portfolio would have contained 7,594 Intel shares — worth $438,554 — by 1992.

That figure has at least doubled, despite the current recession, in the ten years since. Name any other investment that has offered such a return over the course of three decades.

Obviously, Intel is a special case. Still, a shrewd investor, with a well balanced portfolio of semiconductor stocks, is looking at one of the best long-term plays around.

Potential for Winning Big

And there's more: Take a look some time at the membership rolls of the Semiconductor Industry Association (you can visit www.semichips.org/mem_list.cfm). You'll be amazed at the number of new chip companies you've never heard of.

Newer ones appear every month — thanks to new design technologies, "fab-less" business models, and opportunities in photoimagery, telecom and the Net.

This is, in fact, one of the best times in years for new chip companies. And that means the potential for big wins — perhaps not Intel big, but big enough.

Semiconductor companies have done a better job of making everyday investors rich than almost any other industry. In that regard, nothing has changed. And there are more opportunities for those investments, especially at the ground level, than at any time in a quarter-century. You just need to be prepared for a very, very bumpy ride.

And that's why, no matter what hot new tech industry captures the world's imagination, chips still reign … and this remains the Valley of Silicon.

Michael S. Malone, once called “the Boswell of Silicon Valley,” is editor-at-large of Forbes ASAP magazine. His work as the nation’s first daily high-tech reporter at the San Jose Mercury-News sparked the writing of his critically acclaimed The Big Score: The Billion Dollar Story of Silicon Valley, which went on to become a public TV series. He has written several other highly praised business books and a novel about Silicon Valley, where he was raised. For more, go to Forbes.com. And you can talk back to Silicon Insider via e-mail.