Why This Semiconductor ETF Might Be the Most Underrated AI Play Right Now

The artificial intelligence (AI) revolution has been led by semiconductor stocks, as chipmakers are the vehicles that enable AI. Chip stocks have been the hottest on the market through the AI boom, but there has been some pullback this year as investors are concerned about high valuations and whether huge investments are actually paying off for some companies.

Investors hesitant to jump into AI stocks now, particularly those trading at high multiples, should look at the First Trust Nasdaq Semiconductor ETF (NASDAQ: FTXL). It may not be as well-known as many of the larger semiconductor ETFs, but I think it is the perfect semiconductor ETF for the market right now.

Here's why.

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Why the First Trust Nasdaq Semiconductor ETF is the best chipmaker ETF

There are a few things about the First Trust Nasdaq Semiconductor ETF that set it apart from most of its competitors and make it appealing right now.

Let's start with its construction. It is not actively managed; it tracks the Nasdaq US Smart Semiconductor index, which includes certain screens and factors that position it well to navigate this market. The index ranks semiconductor stocks based on four factors: gross income, return on assets, momentum, and cash flow. It then selects the 30 to 50 chip stocks with the best scores, below a certain cutoff score. In this case, as in golf, the lower the score, the better.

Hereʻs a key difference -- the portfolioʻs stocks are weighted by cash flow, not market cap. So, it's basically a quality screen: the stocks that generate the most real cash flow, after expenses are accounted for, have the most weight. So, high-flying momentum AI stocks with little or no cash flow but a lot of hype would not be overweighted.

This seeks to ensure that the most stable, sturdy growers are prominently featured in the portfolio.

Currently, the portfolio holds 34 chip stocks, with Intel, Micron Technology, and Marvell Technology being the three largest holdings.

In addition, FTXL has screens in place to make sure no stock takes up too much of the portfolio. At roughly 34 holdings or more, it is more diversified than some of the major semiconductor ETFs.

98% return year-to-date

The First Trust Nasdaq Semiconductor ETF has been one of the best-performing chip ETFs over the past year. The ETF has returned a stellar 98% year to date and 161% over the past 12 months. Few semiconductor ETFs that arenʻt leveraged have had better returns.

While it does not yet have a 10-year track record, the ETF has had strong three- and five-year returns. On an annualized basis over the last three years, it has returned 54.4% per year, and over the past five years, it has averaged a 30.7% annual return.

Those longer-term returns stack up well against large chip ETFs like VanEck Semiconductor ETF (NASDAQ: SMH), iShares Semiconductor ETF (NASDAQ: SOXX), Invesco Semiconductors ETF (NYSEMKT: PSI), and State Street SPDR S&P Semiconductor ETF (NYSEMKT: XSD).

Data by YCharts.

Overall, given its quality screens and cash flow weighting, the First Trust Nasdaq Semiconductor ETF is the best chip ETF you can buy, particularly right now, given that AI stocks are overvalued.

Dave Kovaleski has positions in Micron Technology. The Motley Fool has positions in and recommends Intel, Marvell Technology, Micron Technology, and iShares Trust-iShares Semiconductor ETF. The Motley Fool has a disclosure policy.