Applied Materials looks good, and is at the forefront of IT innovation.
The market was infatuated Nvidia since a few years. So much so that this month, it is again the largest company in the world by market capitalization, with a net worth of more than $ 3.5 trillion. The artificial intelligence (AI) boom has been a huge boon for business, and with the stock up more than 10 times in just a few years, it would be understandable for investors who didn’t get in early to think they missed out. the boat .
So what should an investor do now if they want to open a new position that will allow them to ride the AI wave? A promising AI that took a fall this year is Applied Materials (AMAT -0.49%). The semiconductor equipment manufacturer is hit by a slowdown in sales in China, but smart investors know that this is only a temporary wind for a business with a wide moat. Here’s why now is the time to buy the dip in Applied Materials.
Applied Materials: The machines that make the machines
Many investors now know that Nvidia – like many other companies – designs computer chips that are used extensively in modern life. From data centers to smartphones to virtual reality glasses, the world is powered by semiconductors.
Building advanced semiconductors requires a lot of innovation, and making them progressively smaller and more powerful requires intricate, advanced machines. This is where Applied Materials comes in. Without going into the most important details, the company produces the equipment and software that semiconductor manufacturers use to package, etch and shape their chips. Its technology allows manufacturers to produce chips with higher performance, lower electricity consumption and a smaller surface area – attributes valued in the semiconductor industry.
Given the importance of these factors in the construction of chips, Applied Materials is able to charge a lot for its machines and the service contracts that come with them. In the last four reported quarters, it generated $27 billion in revenue from customers around the globe.
Free cash flow growth, shares outstanding fall
Applied Materials’ financial performance has been phenomenal over the long term. Its free cash flow over the past four quarters was $7.5 billion, and it has been cash flow positive for every 12-month period in the 21st century. Although Applied Materials operates in a cyclical industry, it has been able to consistently generate positive cash flow because of the importance of its machines to manufacturers.
With all the money coming into the business, the company was able to buy back a lot of stock. Since 2003, it has reduced its number of shares outstanding by more than 50%, which has helped it grow its earnings per share (EPS) and free cash flow per share. For investors, these are two of the most important metrics to track as they are what create long-term shareholder value. Free cash flow per share has increased nearly 800% over the past 10 years.
ACHR Operating Income (TTM) data from YCharts.
Why you should buy the dip in Applied Materials stock
Investors sold shares of Applied Materials because of its China revenue that fell sharply in its last fiscal quarter. During its fiscal Q4, which ended on October 27, its revenue in China fell to $2.1 billion compared to $3 billion in the same period a year ago. Semiconductor manufacturers in China are ordering a lot of machines because of the threatened or existing export restrictions from the United States. Investors see these trade restrictions as a major windfall for a segment that accounted for 30% of Applied Materials’ revenue last quarter.
While this is a concern in the short term, the world will need more computer chips regardless of where they are manufactured. If the tools to make them are less available to companies operating in China, then their production happens in other nations. But Applied Materials still finds demand for its highly sought-after machines.
After the recent selloff, Applied Materials is now trading more than 33% below its all-time high. Its shares trade at a price-to-earnings ratio (P/E) of 20 and a forward P/E of 17.7, based on analyst estimates – well below S&P 500 P / E average of the index of 30. For a company that should grow with the growing semiconductor market, these earnings reports seem too cheap. So buy some shares of Applied Materials stock on this dip, and hold on to them for the long haul.
Brett Schafer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Applied Materials and Nvidia. The Motley Fool has a disclosure policy.