Applied Materials: Navigating the Future of Semiconductor Innovation.

Applied Materials is one of the most important companies in the global semiconductor supply chain, providing the manufacturing equipment, services, and software used to produce advanced chips. Its technology supports a wide range of applications, including smartphones, data centers, artificial intelligence, and vehicles. With strong positions across many steps of the chipmaking process and a growing services business that adds stability to a cyclical industry, Applied Materials benefits from long-term demand for computing power. The question remains: does this semiconductor company deserve a place in your portfolio?

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For full disclosure, I should mention that I do not own any shares in Applied Materials at the time of writing this analysis. If you would like to copy or view my portfolio, you can find instructions on how to do so here. 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 $50.

The Business

Applied Materials, founded in 1967 in California, is the world’s leading provider of materials engineering solutions used to manufacture semiconductors and advanced displays. Rather than producing chips itself, the company supplies the highly specialized equipment, services, and software that enable chipmakers to fabricate ever more complex devices. As a result, Applied Materials occupies a structurally critical position in the global semiconductor supply chain. The company’s core expertise lies in modifying materials at the atomic level and doing so reliably at industrial scale. This capability is essential as semiconductor manufacturers push toward smaller transistor dimensions, three-dimensional architectures, and advanced packaging. Applied Material’s tools are used across virtually all end markets that rely on computing power, including personal electronics, artificial intelligence, data centers, automotive systems, industrial automation, and connected devices. Applied Materials operates primarily through two core segments. The Semiconductor Systems segment is the company’s largest and most strategically important business. It designs, develops, and manufactures equipment used throughout the semiconductor fabrication process, including deposition, etching, ion implantation, process control, inspection, metrology, and advanced packaging. What differentiates Applied Materials is not only the breadth of this portfolio, but its ability to integrate and co-optimize multiple process steps. As chip architectures become more complex, performance and yield increasingly depend on how well individual manufacturing steps work together, rather than on isolated tools. Applied Material’s integrated approach allows customers to improve power efficiency, performance, yields, and cost structures simultaneously, making it a key enabler of continued semiconductor scaling and integration. The Applied Global Services (AGS) segment functions as the company’s recurring revenue engine. It provides maintenance services, system upgrades, spare parts, automation software, and productivity solutions for Applied Material’s large installed base of equipment worldwide. With tens of thousands of tools operating in customer fabs, AGS generates stable, high-margin revenue that helps offset the cyclicality of semiconductor capital spending. This segment also strengthens long-term customer relationships and embeds Applied Material more deeply into customer operations. Applied Materials’ competitive moat is built on its ability to cover almost every key step in chip manufacturing, its massive scale and research spending, very high switching costs from its installed base, and long-standing relationships with the world’s leading chipmakers. First, Applied Materials stands out because it can address almost the entire chip-making process rather than just one narrow step. While many competitors specialize in a single type of tool, Applied provides equipment across deposition, etching, process control, and advanced packaging. This allows it to solve manufacturing problems in an integrated way, which is increasingly important as chips become more complex and three-dimensional. Second, scale and research spending are major advantages. With more than $3 billion spent annually on research and development, Applied Materials can work on the most difficult physics and materials challenges involved in next-generation chips. Few competitors can afford to invest at this level year after year. Third, switching costs are extremely high. Once a chipmaker builds its production process around Applied Material’s tools, replacing them would be costly and risky. It would require requalifying processes, retraining engineers, and integrating new tools into factory software, making changes very unattractive. Finally, Applied Materials benefits from decades-long relationships with the leading foundry, logic, and memory manufacturers, backed by a global service and support network.

Management

Gary Dickerson serves as the CEO of Applied Materials and has been a member of the company’s Board of Directors since 2013. He joined Applied Materials in 2011 following the acquisition of Varian Semiconductor Equipment Associates, where he had served as CEO. After holding several senior leadership roles within Applied Materials, he was appointed CEO at a time when the company was facing intense competition and growing technological complexity in semiconductor manufacturing. Gary Dickerson brings deep operational and industry experience built over several decades in the semiconductor and industrial technology sectors. Prior to joining Varian, he held leadership positions at KLA Tencor Corporation, General Motors, and AT&T Technologies, giving him a rare combination of semiconductor process knowledge, manufacturing discipline, and large scale operational management. He holds a Bachelor of Science degree in Engineering Management from the University of Missouri Rolla and an MBA from the University of Missouri Kansas City. Since becoming CEO, Gary Dickerson has led a strategic transformation of Applied Materials with a strong emphasis on innovation, customer collaboration, and long term value creation. One of the defining features of his leadership has been a sustained increase in research and development investment, aimed at strengthening Applied Materials’ leadership in materials engineering and enabling customers to tackle the rising complexity of advanced nodes, three dimensional architectures, and advanced packaging. This focus has helped Applied Materials gain market share, deepen customer relationships, and expand its role across more steps of the semiconductor manufacturing process. Under Gary Dickerson’s leadership, Applied Materials has also built a more resilient business model by growing its services and software activities, improving margins, and generating more recurring revenue from its installed base. His management approach is often described as customer centric and execution focused, with a clear understanding that long term success in semiconductor equipment depends on trust, reliability, and deep integration into customer roadmaps. His performance as CEO has been widely recognized. Gary Dickerson has been named among the top performing CEOs by publications such as Barron’s, Forbes, and the Harvard Business Review, reflecting strong shareholder returns, consistent operational execution, and strategic clarity over a long period. Overall, Gary Dickerson has proven to be a highly capable and strategically minded leader. His deep industry expertise, long term focus on innovation, and disciplined capital allocation have positioned Applied Materials as a central enabler of global semiconductor progress. Based on his record to date, I remain confident in Gary Dickerson’s ability to continue leading Applied Materials effectively through the next phase of growth.

The Numbers

The first number we will look into is the return on invested capital, also known as ROIC. We want to see a 10-year history, with all numbers exceeding 10% in each year. Applied Materials has delivered consistently high ROIC for structural reasons rooted in its business model, while the modest decline in recent years reflects cyclical normalization and deliberate forward investment rather than any weakening of the underlying business. Applied Materials earns high ROIC because it operates in a capital-light position relative to the value it creates. The company sells highly complex, IP-intensive equipment, but it does not own semiconductor fabrication plants. Customers carry the heavy capital burden, while Applied captures attractive margins from equipment, services, and software. This structural setup allows earnings to scale without a proportional increase in invested capital. Pricing power and differentiation further support returns. Applied Material’s tools are deeply integrated into customer manufacturing processes and often optimized across multiple production steps. Once a tool is designed into a process flow, customers prioritize reliability, yield, and long-term roadmap alignment over price, supporting strong margins across cycles. The growing services business amplifies this effect. Applied Global Services generates recurring, high-margin revenue from an expanding installed base, with minimal incremental capital required. As services become a larger share of revenue, overall ROIC naturally rises because profits grow faster than the capital base. The slight decline in ROIC over the past three years is largely explained by cycle dynamics and intentional investment. Semiconductor equipment demand peaked in 2021 and 2022, followed by a normalization in customer spending. Earnings declined from unusually high levels, while invested capital remained elevated, lowering ROIC. At the same time, Applied Materials has deliberately stepped up investment, especially in research and development and in technologies needed for more advanced chips. These investments show up on the balance sheet immediately, while the revenue benefits take time to materialize. That timing effect has weighed on ROIC in the short term, even though the investments are meant to strengthen the business long term. Over time, ROIC is likely to move higher again as industry conditions normalize. When semiconductor investment picks up, Applied Materials tends to benefit because its tools are used in the most complex parts of chip manufacturing. In addition, the services business should continue to grow as a share of revenue, which supports returns without requiring much additional capital.

The next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. To put it simply, equity is the part of the company that belongs to its shareholders – like the portion of a house you truly own after paying off part of the mortgage. Growing equity over time means the company is becoming more valuable for its owners. So, when we track book value plus dividends, we’re essentially looking at how much value is being built for shareholders year after year. Applied Materials has grown equity in most years because the company has consistently earned more than it needs to reinvest in the business. In simple terms, it makes solid profits without having to add much capital, which allows equity to build up over time. The main reason is the business model. Applied Materials sells complex and high value equipment, but it does not need to own chip factories itself. Customers carry the heavy capital burden, while Applied benefits from strong margins and a growing services business. This allows earnings to grow faster than the balance sheet. Equity growth has also been supported by a cautious approach to capital allocation. The company has focused on investing internally, mainly through research and development, rather than pursuing large acquisitions that would inflate assets. This has helped equity grow steadily across most years. The few years with weaker or negative equity growth mostly coincide with downturns in the semiconductor cycle, when customer spending slows and profits temporarily come under pressure. These periods have historically been followed by recoveries as demand returns, allowing equity growth to resume. Over time, equity should continue to grow as long as Applied Materials remains profitable and disciplined in how it invests. Results will vary from year to year due to the semiconductor cycle, but the company’s long term ability to grow equity does not appear to have changed.

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 been able to generate strong free cash flow for a long time mainly because of how the business is structured. The company sells high value equipment and services, but it does not need to invest heavily in physical assets to keep operating. Its customers build and finance the fabs, while Applied Materials collects cash from tool sales, services, and software. This makes it easier to turn profits into cash. Another important factor is the services business. Applied Global Services generates steady, high margin cash from the installed base of tools already in customer fabs. This part of the business requires relatively little ongoing investment and provides a stable cash flow stream even when new equipment demand slows. Free cash flow declined in fiscal year 2025, but the reason is very clear. Capital spending was unusually high at $2,3 billion, mainly due to the construction of the new EPIC Center in Silicon Valley. This is a long term investment in research and collaboration rather than a sign of weaker operations. Operating cash flow remained strong, and without this elevated spending, free cash flow would have been higher. Because of that, the decline in free cash flow in 2025 is not something that stands out as worrying. The company still generated close to $5,7 billion in free cash flow during a softer part of the semiconductor cycle, which says more about the strength of the business than about any underlying issue. Applied Materials uses its free cash flow in a fairly straightforward way. A portion is returned to shareholders through dividends, which are well covered by cash generation, especially from services. A large share has also been used for share buybacks, reducing the number of shares outstanding over time. The remaining cash is reinvested into the business, mainly into research, development, and infrastructure that supports long term technology leadership. The free cash flow yield is at its lowest level in more than a decade, which suggests that the shares are trading at a relatively high valuation. Valuation will be discussed 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 0,94 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

The cyclical nature of the semiconductor industry is a risk for Applied Materials because demand for its products depends heavily on the timing and size of customer investment cycles, which are difficult to predict and can change quickly. Applied Materials sells equipment and services primarily when chipmakers decide to build new fabrication plants or upgrade existing ones, and these decisions are often large, lumpy, and easy to delay. They are influenced by end market demand for electronics, data centers, automotive chips, and artificial intelligence, as well as broader economic conditions. When demand is strong, customers tend to invest aggressively, and orders for semiconductor equipment can rise sharply over a short period of time. When demand weakens, customers often respond by postponing or cancelling capital spending, which can lead to sudden declines in revenue and profitability for Applied Materials. Because equipment orders are concentrated around major projects, even small changes in customer plans can have an outsized impact on results. During downturns, Applied Materials must adjust production, inventory, and staffing to lower demand. Even when managed well, these adjustments can lead to higher costs, lower margins, and weaker cash flow in the short term. At the same time, the company must continue investing in research and development and maintain a global support and service infrastructure regardless of where the cycle stands, which can further pressure earnings when volumes fall. Macroeconomic conditions amplify this risk. Economic slowdowns, inflation, higher interest rates, financial market stress, trade restrictions, or geopolitical tensions can cause customers to reduce spending or delay projects. In more severe cases, customers may scale back operations, consolidate, or exit parts of the industry altogether, reducing demand for Applied Materials’ equipment and services.

Regulation is a meaningful risk for Applied Materials because the company operates at the center of a highly globalized and politically sensitive industry, where government policy can directly limit what it is allowed to sell, to whom, and where. Applied Materials generates a large share of its revenue from customers outside the United States, with China historically being its largest single market. Semiconductor equipment is now viewed as strategically important, which has led the United States to impose increasingly strict export controls on advanced tools and technologies sold to China. The impact of these rules is not theoretical. Over the past two years, trade restrictions have materially reduced the portion of the Chinese wafer fabrication equipment market that Applied Materials can serve. In fiscal 2024, restrictions limited access to roughly 10% of the China market. By fiscal 2025, that figure had more than doubled, with Applied Materials no longer able to serve large parts of leading edge logic, domestic NAND, DRAM, and portions of the ICAPS market. This matters because China has accounted for close to 40% of global wafer fabrication equipment spending in recent years, meaning even partial exclusion has a noticeable effect on growth and market share. As a result, Applied Materials has lost share in China, not because its technology became less competitive, but because a growing portion of the market is simply inaccessible. Management has been clear that trade restrictions trimmed growth in fiscal 2025 and reduced the size of the addressable market, and expectations for 2026 already assume lower wafer fabrication equipment spending in China with no meaningful easing of restrictions. The regulatory environment also creates longer term strategic challenges. Trade tensions between the United States and China can lead to sudden rule changes, customer additions to restricted entity lists, or tighter licensing requirements, all of which reduce visibility and make planning more difficult. At the same time, foreign governments may push local chipmakers to rely more on domestic equipment suppliers or encourage partnerships with non United States competitors, which could weaken Applied Materials’ position over time.

Competition is a risk for Applied Materials because the markets it operates in are defined by fast technological change, very demanding customers, and a large number of capable global and regional competitors. Applied Materials competes in segments where customers constantly push for smaller chip dimensions, more complex architectures, new materials, and higher yields. To stay competitive, the company must continuously improve existing tools and successfully introduce new technologies at the right time. If Applied Materials misjudges a technology shift or is slower than competitors in bringing new solutions to market, customers may choose alternative suppliers for critical process steps. Because equipment decisions are often locked in for years once selected, losing a technology transition can result in lost share that is difficult to recover. Competition is particularly intense in core process areas such as deposition, etch, chemical mechanical planarization, and process control. Applied Materials faces strong global competitors, including companies with deep specialization in individual process steps. In some cases, technology transitions can also reduce the importance of certain tools. For example, shifts from one deposition method to another can weaken the position of existing product lines and force Applied Materials to compete aggressively to maintain relevance. This creates ongoing pressure to allocate capital correctly across many product areas, knowing that not every investment will succeed. Export restrictions add another layer to competitive risk. Non United States equipment suppliers are not subject to the same restrictions as Applied Materials, which means restricted customers in China can still buy from international competitors even if they would prefer to use Applied Materials’ tools. As a result, Applied Materials is losing access to parts of the Chinese market while competitors continue to ship equipment. This does not reflect weaker technology, but it does translate into lost revenue, lost share, and weaker customer relationships over time. At the same time, China is investing heavily in building domestic semiconductor equipment suppliers. These companies currently trail Applied Materials in leading edge technology, but they are gaining share in mature nodes where performance requirements are lower. Over time, this could permanently reduce demand for Applied Materials’ tools in parts of the ICAPS market, especially if local suppliers continue to improve with government backing and guaranteed domestic demand.

Reasons to invest

Secular trends present a compelling reason to invest in Applied Materials because the company sits at the center of long term forces that are steadily increasing the need for more advanced, more complex semiconductors and the equipment required to manufacture them. Semiconductors are becoming more important across almost every part of the global economy. Artificial intelligence, data centers, automation, robotics, electric vehicles, energy infrastructure, and edge computing all rely on large amounts of computing power that must be delivered more efficiently than before. This is not a short cycle driven by one product category, but a broad shift in how technology is used. As these applications grow, the semiconductor industry must expand capacity and move to more advanced technologies, which directly increases demand for wafer fab equipment. Artificial intelligence is the most important driver within these trends. AI chips are larger, more complex, and far more demanding to manufacture than traditional processors. They require more process steps, more advanced materials, and tighter tolerances. This increases the amount of equipment needed per wafer and raises the value of each manufacturing step. For Applied Materials, this means higher demand for its most advanced tools. AI is also changing how chips are built. The semiconductor industry is going through a major design shift that only happens occasionally. One example is the move from FinFET transistors to gate all around structures. This change is needed to keep chips fast and energy efficient as they become smaller. These new designs are much harder to manufacture and require extremely precise steps to deposit and remove materials. This is exactly where Applied Materials’ equipment plays a key role. Memory is undergoing a similar change. AI systems are heavily dependent on fast access to data, which has driven rapid growth in high bandwidth memory. Producing high bandwidth memory requires stacking memory chips and connecting them vertically, a process that involves complex etching, deposition, and packaging steps. Applied Materials plays a key role in these processes and has seen strong growth from leading edge memory customers as a result. Looking further ahead, the transition toward more three dimensional memory structures is expected to further increase the need for materials engineering, expanding Applied Materials’ opportunity. Importantly, these secular trends are pushing spending toward the parts of the equipment market where Applied Materials is strongest. Leading edge logic, advanced memory, high bandwidth memory, and advanced packaging are expected to be the fastest growing areas, and Applied Materials holds leading positions across them.

Innovation is a reason to invest in Applied Materials because the company focuses its research and development on the most important technology shifts in semiconductor manufacturing and works very closely with customers long before those technologies reach large scale production. Applied Materials does not innovate in isolation. Its strategy is built around identifying major technology changes early and then co-developing solutions with customers that are already planning the next generation of chips. This gives Applied Materials insight into customer road maps several years ahead and allows it to focus resources on the areas that will matter most, rather than spreading investment evenly across all products. A key part of this innovation model is co-optimization. Rather than improving one tool at a time, Applied Materials works with customers to optimize entire process flows. This means adjusting how different steps interact with each other to improve overall performance and yield. This approach becomes more valuable as chips become more complex and three dimensional, and it strengthens customer relationships because Applied Materials is involved in system level decisions rather than just selling individual tools. The EPIC Center in Silicon Valley reinforces this strategy. It is designed as a collaborative environment where Applied Materials and customers can jointly develop and test next generation manufacturing processes. This shortens development cycles, improves time to market, and increases the likelihood that Applied Materials’ tools become the standard choice when new technologies are adopted at scale. Innovation also supports margins over time. As Applied Materials delivers tools that are critical for enabling new chip designs and AI performance gains, customers place a high value on reliability, yield, and energy efficiency rather than price alone. This supports more durable pricing and helps offset the rising cost and complexity of research and development.

The Applied Global Services segment is a reason to invest in Applied Materials because it adds stability, visibility, and durability to a business that would otherwise be much more exposed to swings in equipment spending. As semiconductor manufacturing becomes more complex, customers depend more heavily on ongoing service, software, and process support to keep their factories running efficiently. Applied Global Services supports customers throughout the full life of their equipment, helping them improve yield, reduce downtime, and lower costs. This makes the relationship between Applied Materials and its customers deeper and more long lasting than a simple equipment sale. A large share of Applied Global Services revenue comes from long term service agreements that function much like subscriptions. These agreements include maintenance, spare parts, and software solutions, and renewal rates are very high. Once a tool is installed in a fab, customers cannot easily replace the service provider without risking lower uptime or yield. This creates predictable, recurring revenue with attractive margins. This recurring revenue profile is especially valuable because it reduces Applied Materials’ exposure to the semiconductor cycle. Even when customers slow down spending on new equipment, they still need to service and optimize the tools already in their fabs. As a result, Applied Global Services tends to remain resilient during downturns and helps smooth overall company results. Applied Global Services is also becoming more important as customers race to bring new technologies into production. As device architectures change, customers rely on Applied Materials not only for tools, but also for support in transferring new processes from pilot lines into full scale manufacturing. This positions Applied Materials as an ongoing partner in production rather than a one time supplier. Financially, the segment continues to perform well. Revenue reached a record level in fiscal 2025, with the recurring parts, services, and software portion growing at a double digit rate. Margins have steadily improved as the mix shifts toward higher value services and software. Over time, this improves cash flow quality and supports stronger returns on capital.

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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 8,66, which is from fiscal year 2025. I have selected a projected future EPS growth rate of 10% (Finbox expects EPS to grow by 10,4% a year over the next five years). Additionally, I have selected a projected future P/E ratio of 20, 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 $111,04. 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 $55,52 (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 7.958 and capital expenditures were 2.260. 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 1.582 in our calculations. The tax provision was 2.273. We have 796,6 outstanding shares. Hence, the calculation will be as follows: (7.958 – 1.582 + 2.273) / 796,6 x 10 = $108,57 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 $7,15 and a growth rate of 10%, if you want to recoup your investment in 8 years, the Payback Time price is $89,94.

Conclusion

I find Applied Materials to be an intriguing company with strong management. The company has built a durable moat through its ability to cover almost every key step in chip manufacturing, its scale and sustained research spending, very high switching costs created by its installed base, and long standing relationships with leading chipmakers. This has allowed Applied Materials to consistently generate high ROIC and strong free cash flow, even though fiscal year results have recently been weighed down by elevated capital expenditures. At the same time, the cyclical nature of the semiconductor industry remains a clear risk, as customer spending on new fabs and equipment can swing sharply and is easy to delay when demand or economic conditions weaken, leading to sudden drops in revenue and profitability while the company must continue investing in research, support, and infrastructure. Regulation is another important risk, as export controls and trade restrictions can directly limit access to key markets, especially China, regardless of customer demand or technology strength, reducing growth, market share, and visibility while increasing reliance on political decisions. Competition also remains a risk, as Applied Materials operates in fast moving markets where missing a technology shift or losing a critical process step can result in long lasting share losses, a challenge made more complex by strong global competitors, growing domestic Chinese suppliers, and restrictions that allow non United States rivals to serve customers that Applied Materials cannot. Against these risks stand powerful long term tailwinds. Secular trends such as artificial intelligence, data centers, and energy efficient computing are driving demand for more complex chips that require more equipment and more materials engineering, pushing spending toward leading edge logic, advanced memory, and packaging where Applied Materials has strong positions. Innovation further supports the investment case, as the company identifies major technology shifts early and works closely with customers to develop solutions that become embedded in future chip designs, strengthening customer relationships and pricing power. The Applied Global Services segment adds another layer of quality by providing high margin, recurring revenue that brings stability and visibility to an otherwise cyclical business, generating steady cash flow even when new equipment spending slows. Taken together, I believe Applied Materials is a high quality company, and buying shares at the Ten Cap price of $108 would represent an attractive long term investment.

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