Applied Materials specializes in manufacturing equipment for the rapidly growing semiconductor industry. The company anticipates that the market for equipment will grow at least as fast as the semiconductor market itself, as advancements in the industry are becoming increasingly complex. To transition from one generation of chips to the next, chipmakers require more advanced technology, which drives demand for Applied Materials' solutions. But is now the right time to invest in Applied Materials? This is the question I will explore in this analysis.
This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own any shares of Applied Materials. If you would like to view the stocks in my portfolio or copy my portfolio, you can do so on eToro. Instructions on how to do so can be found here. I don't own any stocks in Applied Materials' competitors either. Thus, I have no personal stake in Applied Materials. If you want to purchase shares or fractional shares of Applied Materials, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started on investing with as little as $100.
The Business
Applied Materials, founded in 1967 in California, is a global leader in providing manufacturing equipment, services, and software for the semiconductor, display, and related industries. The company specializes in materials engineering, delivering solutions that enhance the performance, power efficiency, yield, and cost-effectiveness of its clients' devices. These devices are central to various applications, including personal electronics, artificial intelligence, data centers, automotive technologies, and industrial systems. The Semiconductor Systems segment is the company’s largest, contributing 73% of Applied Materials’ revenue. This segment focuses on designing, developing, and manufacturing equipment used in semiconductor fabrication, including tools for depositing thin films, etching patterns, modifying material properties, and cleaning wafer surfaces. Applied Materials' ability to integrate and optimize these technologies enables its customers to achieve superior performance and yield, addressing the increasing complexity of chip manufacturing processes. The Applied Global Services segment accounts for 23% of the company’s revenue. This segment offers integrated solutions that enhance the performance and productivity of fabrication plants worldwide. Its offerings include maintenance services, system upgrades, automation software, and spare parts for semiconductor and display equipment. With a large installed base and a robust global distribution network, this segment generates stable, high-margin recurring revenue. The Display and Adjacent Markets segment, which contributes 4% of revenue, focuses on equipment used in producing advanced display technologies such as liquid crystal displays (LCDs) and organic light-emitting diodes (OLEDs). These displays are critical components in TVs, laptops, smartphones, and emerging technologies like virtual reality. Applied Materials benefits from strong customer relationships built over decades and an expansive global distribution network, which enables the company to maintain its leading market position. Its comprehensive product portfolio, technological leadership, and ability to tackle challenges associated with shrinking chip dimensions and vertical stacking give it a significant moat. Geographically, the company’s operations are well-diversified, with China being the largest market and contributing 37% of revenue, followed by South Korea, Taiwan, the United States, Japan, and Europe.
Management
Gary Dickerson is the CEO of Applied Materials. He joined the company in 2011 following its acquisition of Varian Semiconductor Equipment Associates, where he served as CEO. After holding various leadership roles at Applied Materials, Gary Dickerson became the CEO and a member of the Board of Directors in 2013. Before joining Varian Semiconductor Equipment Associates, he held leadership positions at KLA-Tencor Corporation, General Motors, and AT&T Technologies. He earned a Bachelor of Science degree in Engineering Management from the University of Missouri, Rolla, and an MBA from the University of Missouri, Kansas City. Gary Dickerson brings extensive experience in the semiconductor industry, with a proven track record of driving profitable growth, gaining market share, and achieving outstanding customer satisfaction. His leadership has been recognized by Barron's, Forbes, and the Harvard Business Review, which have named him among the top-performing CEOs. Known for his focus on innovation, Gary Dickerson has significantly increased research and development spending at Applied Materials. This emphasis on R&D has delivered strong outcomes for shareholders by fostering new product development and maintaining the company’s technological leadership. However, a concern under his leadership is the recent subpoena Applied Materials received from the U.S. Attorney's Office, related to a potential evasion of export restrictions to China. While this issue poses a challenge, Gary Dickerson’s overall performance as CEO has been remarkable, and his strategic direction has consistently positioned the company for success. I remain confident in his ability to lead Applied Materials effectively in the future.
The Numbers
The first metric we will investigate is the return on invested capital (ROIC). Ideally, we seek a 10-year history with all figures consistently exceeding 10% annually. Applied Materials has consistently achieved a ROIC of over 10% for the past decade. What’s even more remarkable is that the ROIC has been above 20% since 2017 and exceeded 30% from 2021 until it dropped slightly below 30% in fiscal year 2024. The slight decrease in fiscal year 2024 can be attributed to Applied Materials' significant investments in semiconductor equipment, which are expected to enhance long-term ROIC. Given that the ROIC in fiscal year 2024 was still an impressive 29,3%, this minor decline is not concerning. Moreover, these strategic investments should bolster ROIC in the long term, further reinforcing the company's strong financial performance.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most significant of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. Overall, the figures appear satisfactory. While Applied Materials has experienced some decreases in certain years, these fluctuations are not a cause for concern. Notably, the figures have reached new peaks since 2020, and it is encouraging that Applied Materials achieved its highest equity levels in fiscal year 2024. Additionally, the year-over-year increase in equity has exceeded 10% in five of the past six years, which is a highly impressive performance and reflects the company's strong financial foundation.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. Applied Materials has consistently achieved positive free cash flow every year for the past decade, which is not surprising given its strong operational efficiency. It is particularly impressive that the company has grown its free cash flow at a compounded annual growth rate of nearly 23% over the past decade. While free cash flow decreased slightly in fiscal year 2024, this was due to record-high capital expenditures as Applied Materials made significant investments in semiconductor equipment. These investments are expected to enhance free cash flow over the long term. As Applied Materials continues to grow its free cash flow, investors stand to benefit, as the company aims to return 80% to 100% of its free cash flow to shareholders through share buybacks and dividends. Historically, Applied Materials has delivered a high levered free cash flow margin, and it is encouraging that the company achieved its second-highest levered free cash flow margin in fiscal year 2024, despite its elevated investments. The free cash flow yield is currently below the ten-year average but remains above 5%, indicating that the shares are trading at an attractive valuation. However, this is a point that will be explored further later in the analysis.
Debt
Another important aspect to evaluate is the level of debt. It is crucial to ensure that a business has a manageable debt level that can be repaid within a three-year period. This is assessed by dividing the total long-term debt by earnings. Based on my analysis of Applied Materials, the company has a debt-to-earnings ratio of 0,76 years, which is well within the three-year threshold. This indicates that debt is not a concern when considering an investment in Applied Materials. Moreover, Applied Materials has maintained a debt-to-earnings ratio below three years for the past decade, demonstrating prudent financial management. Given this track record, it is unlikely that debt will pose a significant concern for the company in the future either.
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Risks
Macroeconomic factors pose significant risks to Applied Materials due to its reliance on global economic conditions, consumer and business spending, and the demand for semiconductor chips and electronic devices. Economic uncertainty, such as recessions, inflation, rising interest rates, financial market volatility, and supply chain disruptions, can negatively impact the company's business by reducing customer spending. This may result in order cancellations, lower demand for equipment and services, increased inventory levels, and weakened operating results. Supply chain challenges, including shortages of parts and materials or transportation delays, further complicate production schedules and can lead to increased costs. Additionally, economic pressures on customers may cause operational cutbacks, bankruptcies, or consolidation within the industry, further diminishing demand for Applied Materials' products and services. These macroeconomic challenges also make forecasting and operational planning more difficult, forcing the company to carefully balance cost reductions with continued investments in research and infrastructure to maintain its competitive edge. This dynamic can strain profitability, particularly during periods of heightened economic uncertainty.
Regulations present a significant risk to Applied Materials due to the globalized and politically sensitive nature of the semiconductor industry. The company is particularly vulnerable to export restrictions, such as those recently imposed by the United States on semiconductor equipment sold to China, its largest market. While management has indicated that current restrictions have not materially affected operations, future regulatory changes could severely limit the company's ability to sell products and services in China, reducing revenue streams and increasing competition from both local and foreign companies. In addition to these export restrictions, Applied Materials has faced scrutiny from U.S. authorities for potential violations of export controls. Allegations include bypassing restrictions by routing sales through subsidiaries in South Korea, raising legal and compliance risks. Such investigations, combined with the complexity of navigating evolving regulations, pose significant legal, financial, and operational challenges for the company. Global trade tensions, particularly between the United States and China, further exacerbate these risks. Policy changes such as the inclusion of customers on the "Entity List," stricter export licensing requirements, or retaliatory measures by foreign governments could disrupt Applied Materials' supply chain, inflate production costs, and constrain its ability to meet customer demand. Additionally, foreign governments may favor domestic suppliers or enforce partnerships with local competitors, potentially eroding Applied Materials' market position. These challenges are particularly acute in key markets like China and Korea, which account for a significant portion of the company’s business. The dynamic regulatory environment not only creates immediate operational hurdles but also poses longer-term risks to Applied Materials' revenue, profitability, and competitive standing in the global semiconductor industry.
Competition is a significant risk for Applied Materials due to the dynamic and technologically demanding nature of the industries it serves. The semiconductor, display, and services markets are defined by rapid innovation, evolving customer requirements, and intense global competition. To maintain its leadership position, Applied Materials must consistently innovate, develop new products, and adapt existing offerings to address increasingly complex demands, including smaller chip dimensions, advanced architectures, and new materials. Any failure to respond effectively to these technological shifts could diminish the value of its portfolio, erode its competitive advantage, and allow rivals to capture market share. The competitive landscape is further complicated by small regional players benefiting from local government incentives, as well as large global competitors with diversified portfolios and extensive international reach. Export controls, particularly U.S. restrictions on technology sales to China, exacerbate these challenges by limiting Applied Materials’ market access while simultaneously creating opportunities for international competitors and subsidized Chinese firms. As China represents the company’s largest market, such restrictions pose a significant threat to its revenue and growth potential. Additionally, as semiconductor and display technologies evolve, competitors may introduce innovative solutions that outpace Applied Materials' offerings, making it more difficult to secure new customers or retain existing ones. The increasing presence of firms specializing in advanced automation, AI-driven solutions, and next-generation materials further intensifies the competitive pressure. This dynamic, combined with geopolitical uncertainties and the need to keep pace with technological advancements, presents both immediate and long-term risks to Applied Materials' market position, profitability, and growth prospects.
Reasons to invest
Secular trends present a compelling reason to invest in Applied Materials because the company is exceptionally well-positioned to benefit from transformative technological shifts that are driving sustained demand for semiconductors and materials engineering solutions. Emerging advancements in areas such as artificial intelligence, energy-efficient computing, automation, robotics, electric and autonomous vehicles, and clean energy are fundamentally reshaping the global economy, with semiconductors serving as the backbone of these innovations. These trends create significant growth opportunities for the semiconductor industry and for Applied Materials, whose cutting-edge solutions are integral to enabling next-generation technologies. The projected growth of the semiconductor market to $1 trillion by 2030 highlights the immense scale of the opportunity. This growth is underpinned by consistent annual capacity expansions needed to meet demand across key end markets such as AI, data centers, smartphones, and edge computing. These markets increasingly rely on advanced nodes, architectures, and energy-efficient designs, areas where Applied Materials excels with its integrated systems that enhance manufacturing performance and improve energy efficiency. By addressing critical technological challenges and expanding its addressable market through leadership in materials engineering, Applied Materials is strategically positioned to capitalize on these secular megatrends. Its ability to innovate and provide solutions at the forefront of these advancements ensures that it will continue to play a vital role in the evolution of the semiconductor industry. With these long-term trends driving sustained demand, Applied Materials is well-positioned for growth and differentiation in an increasingly competitive and dynamic landscape.
Leadership in materials-driven innovation is a compelling reason to invest in Applied Materials, as the company plays a pivotal role in advancing critical changes in semiconductor design and manufacturing. As chips become more advanced, materials engineering has become indispensable for enhancing performance, energy efficiency, and cost-effectiveness. Applied Materials is uniquely positioned to address these challenges, helping its customers develop next-generation technologies and enabling breakthroughs in chip design. One significant growth opportunity for the company lies in new chip architectures, such as gate-all-around transistors, which enhance speed and energy efficiency. Applied Materials provides the specialized tools and expertise necessary to manufacture these designs, which contributed significantly to the company's revenue in 2024, with even stronger growth anticipated in 2025. Additionally, the increasing demand for memory chips - critical for artificial intelligence, data centers, and other advanced technologies - is driving robust growth for Applied Materials. Another area of strength for the company is advanced packaging, a process in which multiple chips are integrated into a single unit to improve speed, efficiency, and functionality. Applied Materials has invested in this technology for years, and it has become a key driver of revenue growth as the industry adopts this innovative approach more widely. What sets Applied Materials apart is its deep collaboration with customers to develop customized solutions. By working closely with partners, the company not only stays ahead of industry trends but also helps its customers accelerate their own innovation. Its expertise in materials engineering - optimizing and enhancing the materials used in chipmaking - solidifies its leadership position in the semiconductor industry, making it a critical enabler of technological progress.
The Applied Global Services (AGS) segment is a compelling reason to invest in Applied Materials because it provides consistent, high-margin, and recurring revenue streams that bolster the company's financial stability and long-term growth potential. AGS addresses the increasing complexity of semiconductor manufacturing by offering advanced services and support designed to optimize customer operations and extend the lifecycle of Applied Materials' tools. The segment's track record is impressive, with 21 consecutive quarters of year-over-year growth, underscoring its resilience and robust demand. A significant portion of AGS revenue comes from long-term service agreements, which not only provide predictable income but also demonstrate strong customer loyalty, with renewal rates exceeding 90%. These agreements are also increasing in duration, with the average contract now lasting 2.9 years, further enhancing revenue predictability. The installed base of Applied tools covered by service agreements has grown by 10% year-over-year, creating a larger opportunity for recurring revenue as customers continue to rely on Applied Materials' expertise and support. This combination of a growing installed base, extended contract durations, and high renewal rates makes AGS a dependable and expanding revenue generator. Beyond its contribution to revenue, the AGS segment plays a critical role in reducing Applied Materials' exposure to the cyclical nature of semiconductor equipment spending. Its recurring revenue model provides a steady income stream that offsets volatility in other segments, ensuring consistent profitability. By leveraging AGS, Applied Materials not only supports its customers' evolving needs but also strengthens its financial foundation, making it a key driver of the company's long-term success.
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Valuation
Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators for free.
The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 8,61, which is from fiscal year 2024. I have selected a projected future EPS growth rate of 9% (Finbox expects EPS to grow by 9,4% a year over the next five years). Additionally, I have selected a projected future P/E ratio of 18, which is double the growth rate. This decision is based on the fact that Applied Materials has historically had a higher P/E ratio. Lastly, our minimum acceptable rate of return is already set at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $90,69. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Applied Materials at a price of $45,35 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is called the Ten Cap price. The rate of return that an owner of a company (or stock) receives on the purchase price of the company is essentially its return on investment. The minimum annual return should be at least 10%. I calculate it as follows: The operating cash flow last year was 7.657 and capital expenditures were 1.092. I tried to review their annual report to calculate the proportion of capital expenditures designated for maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 764 in our calculations. The tax provision was 975. We have 818 outstanding shares. Hence, the calculation will be as follows: (7.657 – 764 + 975) / 818 x 10 = $96,18 in Ten Cap price.
The final calculation is called the Payback Time price. It is a calculation based on the free cash flow per share. With Applied Materials' Free Cash Flow Per Share at $9,08 and a growth rate of 9%, if you want to recoup your investment in 8 years, the Payback Time price is $109,15.
Conclusion
I find Applied Materials to be an intriguing company with strong management. The company possesses a competitive moat through its extensive product portfolio, technological leadership, and ability to address industry challenges, such as shrinking chip dimensions and vertical stacking. It has consistently delivered a high return on invested capital (ROIC) and achieved a remarkable free cash flow growth rate of 23% compounded annually over the past decade, while also improving its levered free cash flow margin. That said, macroeconomic factors, including recessions, inflation, and supply chain disruptions, pose significant risks by potentially reducing demand and straining profitability. Regulatory challenges, particularly U.S. export restrictions targeting China, could limit Applied Materials' sales in its largest market and intensify competition. Additionally, the fast-evolving nature of the semiconductor market and competition from both regional and global players present challenges to maintaining its market position. On the positive side, secular trends like artificial intelligence, energy-efficient computing, and clean energy present significant growth opportunities for Applied Materials. The company is uniquely positioned to capitalize on the increasing demand for semiconductors driven by these transformative technologies. Its leadership in materials-driven innovation and its Applied Global Services segment, which generates high-margin, recurring revenue, further bolster its competitive edge. Overall, I believe Applied Materials has strong long-term potential. Buying shares below $144, offering a 25% discount on the Ten Cap price, represents a solid investment opportunity for those looking to capitalize on its growth and resilience in a dynamic industry.
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