AI Chips and Software: Unlocking Undervalued Growth in the Semiconductor Boom

The semiconductor industry is undergoing a paradigm shift, driven by the explosive growth of artificial intelligence (AI). As companies race to capitalize on AI's transformative potential, investors are seeking undervalued opportunities where AI revenue catalysts are underappreciated. This article highlights key players in semiconductors and software poised to thrive in the AI era, leveraging their exposure to critical trends while trading at attractive valuations.

Image of ON Semiconductor's silicon carbide (SiC) chips, central to electric vehicle (EV) power systems

ON Semiconductor (NASDAQ: ON): The Undervalued EV and AI Play

ON Semiconductor is a standout pick for investors seeking exposure to AI-driven growth at a compelling valuation. The company's silicon carbide (SiC) chips, critical for EV efficiency and renewable energy systems, are already embedded in over 10 automaker platforms. With EVs expected to command ~15% of global car sales by 2025, ON's automotive revenue—now 32% of total sales—is primed for outsized growth.

Why It's Undervalued:
- P/B Ratio: 2.62 (below its 13-year median of 3.31 and the industry average of 2.22).
- Free Cash Flow: Jumped 72% YoY to $455 million in Q1 2025, supporting a $300 million buyback program.
- Upside Potential: Analysts project a fair value of $62.76, implying a 25% upside from its June 2025 price of $50.28.

Analog Devices (ADI): Diversified Growth in AI-Driven Markets

Analog Devices' $2.64 billion Q2 revenue (up 22% YoY) reflects its strategic positioning across automotive electrification, industrial automation, and AI infrastructure. Key highlights:
- Automotive: Revenue grew 14.6% to $849.5 million, driven by SiC power semiconductors and ADAS sensors.
- AI Infrastructure: Communications segment revenue rose 10.6% to $315 million, fueled by data center demand.
- Valuation: Trading at 69.4% gross margins and a $1.6 billion net cash position, ADI offers a rare blend of profitability and financial flexibility.

Catalyst: Its $1.6 billion net cash and track record of strategic acquisitions (e.g., Linear Technology) position it to capitalize on M&A opportunities in AI-enabled hardware.

Industry-Wide Trends: AI's Impact on Valuation Metrics

The semiconductor sector's AI boom is reshaping valuation benchmarks:
- Revenue Multiples: AI-focused firms like NVIDIA trade at 30+ times sales, but undervalued players like ON and ADI offer P/S ratios under 2x, despite strong AI-linked growth.
- Supply Chain Risks: Geopolitical tensions (e.g., U.S.-China chip restrictions) and material shortages (gallium, germanium) highlight the need for diversified supply chains—a strength for ADI and ON.
- Software Synergy: Companies with AI-driven software stacks (e.g., VMware Cloud Foundation) see recurring revenue streams, a key differentiator for Broadcom but underappreciated in ON's expanding IoT offerings.

Key Risks to Monitor

• Talent Shortages: The industry faces a 100,000-worker annual deficit, requiring investments in education and AI design tools to bridge gaps.
• Valuation Squeeze: Elevated P/S ratios in the sector may compress if AI adoption slows or macroeconomic headwinds persist.

Investment Takeaways

1. Buy ON Semiconductor: Its undervalued metrics and secular exposure to EVs/AI make it a top pick.
2. Hold Analog Devices: Diversified revenue and strong margins justify its current valuation.
3. Avoid Overhyped Names: Steer clear of speculative AI stocks trading at P/S >50x (e.g., some cloud infrastructure startups) without proven revenue traction.

The semiconductor industry's AI-driven transformation is here to stay. Investors who focus on undervalued players with tangible AI revenue streams—like ON and ADI—are positioned to profit handsomely as the sector matures.

Final Note: Always consider geopolitical risks and supply chain dynamics. For conservative investors, pair these positions with exposure to defensive names like Taiwan Semiconductor (TSM), which trades at a bargain valuation while underpinning the global AI chip boom.