Is Applied Materials a Top AI Stock?

Applied Materials (NASDAQ:AMAT) is one of the world’s two largest semiconductor manufacturing equipment companies and does business with practically every major business that manufactures chips. Applied Materials boasts a customer list that includes the likes of NVIDIA, Apple, Intel and Boeing, to name just a few.

Thanks to the rise of AI over the past year and a half, demand for newer and more powerful semiconductors has never been higher.

While companies fight for market share in this new and dynamic chip market, the major players are still turning to Applied Materials for their manufacturing tools. As a result, AMAT stock may very well be a ground-floor pick-and-shovel play on the entire semiconductor industry.

Is AMAT a top AI stock that can deliver on its promise?

Applied Materials Investment Thesis

The basic investment thesis behind AMAT stock at the moment is that the ongoing surge in AI investment will increase demand for the company’s manufacturing equipment.

Rather than selecting a chipmaker like NVIDIA or AMD to emerge as the winner in the semiconductor arena, Applied Materials offers investors an option that can benefit from chip demand no matter what company is actually making the chips.

Beyond rising organic demand for chips, the US government is also heavily incentivizing chip manufacturers to build new facilities in the United States.

About $30 billion has been earmarked in the federal budget to subsidize domestic advanced semiconductor manufacturing. As new facilities are built, Applied Materials stands to benefit from this federal largesse by selling the equipment needed by manufacturers.

Finally, Applied Materials is in an excellent position to benefit from developments in the next generation of semiconductor chips. The company’s investments in pattern-shaping technology make it a go-to solution as manufacturers move into chips with nodes of 2nm and lower.

As these smaller and more powerful chips gradually replace the 5nm standard, companies will increasingly have to lean on Applied Materials’ cutting-edge technology to build their most advanced semiconductors.

Applied Materials Performance and Outlook

This investment thesis is padded out by the fact that Applied Materials is already delivering excellent performance results.

In the last 12 months, the company has reported $26.5 billion in revenue and $6.9 billion in net income. Revenue for Q1 was flat on a year-over-year basis, but net income rose by 9%.

The flat revenue in the last year also masks a longer-term trend of steady growth. As recently as 2019, for instance, the company generated just $14.6 billion in revenue, a bit more than half of today’s numbers.

Looking forward, analysts expect to see the company continue to raise both its top and bottom lines as chipmakers continue buying new equipment. For the forward 12-month period, revenues are expected to climb by 5.2% while earnings per share rise a bit more assertively at 7.8%.

As with trailing growth, though, the real story on forward growth is the long-term outlook. Over a span of 3-5 years, earnings are expected to grow at about 11.2% on a compounded annual basis.

Applied Materials also has a solid financial foundation to power ongoing growth. The company’s debt-to-equity ratio is a modest 0.3, making its obligations quite manageable.

As of the last earnings report, the company’s reserve of cash and cash equivalents was $7.1 billion, up markedly from $6.1 billion in the year-ago period.

Is Applied Materials On Sale?

AMAT shares command premium pricing, though this isn’t terribly surprising given both its current performance and growth outlook.

The stock trades at 26.7x forward earnings, 2.9x expected earnings growth, 6.9x sales and 25.4x cash flow. These ratios are all fairly high, reflecting investors’ expectations that the AI boom will translate to sharply higher revenues and net incomes for the company.

Though there are certainly some assumptions baked into Applied Materials’ valuation, it’s very possible that the company will deliver enough growth to make it worthwhile.

With that said, there doesn’t seem to be a good case for AMAT being substantially undervalued. Analysts foresee an upside of about 8.2% over the coming year, with the stock rising from its current price of $221.75 to a median forecast of $240 per share.

What Is The Most Promising AI Stock?

Applied Materials is arguably the most promising AI stock now because it is a pick-and-shovel play on artificial intelligence that is independent of any single chip designer.

It has what Peter Lynch might call a good story. That is to say, the company has an excellent growth opportunity in front of it due to developments in its industry and likely has the resources, market position and know-how to take full advantage of that opportunity.

Institutional capital certainly seems to subscribe to a positive outlook for AMAT, as about 80% of the outstanding shares are owned by institutional investors.

Another point here is the fact that the company’s low debt level and strong cash flows have allowed it to begin returning cash to shareholders via buybacks and dividends.

The preferred method historically has been share repurchasing, which the company has been pursuing with few interruptions since 2010. In Q1 alone, the company bought back about $820 million worth of its own shares.

The company’s dividend track record is a bit shorter at only seven years. Each share of AMAT currently pays $1.60 annually, making for a modest yield of 0.7%.

Over the last three years, though, that payout has grown at a compounded annual growth rate of nearly 12%. With the company still maintaining a dividend payout ratio of 18.4 percent, there’s still quite a lot of space for dividend growth that could eventually make AMAT a decent income investment.

Overall, AMAT looks like a good stock to purchase as a long-term play on rising demand for advanced semiconductors. This stock may not produce enormous returns in the short term, especially with its valuation already somewhat on the high side.

Over several years, though, demand for semiconductor manufacturing equipment could propel the stock considerably higher.

Continued buybacks and dividend increases could also bolster total shareholder returns. AMAT looks like a buy-and-hold stock, but those willing to wait may well enjoy handsome returns on their investments as a reward.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.