Welcome to our latest Foolish feature, the Daily Double. Each market day, we'll be presenting a stock that has doubled in the past six months. For more information on this column, please read "What is the Daily Double."
HOW DID IT DOUBLE?
In mid-July 1996 Applied Materials stock hit a low of $21 3/4, falling from a high of nearly $58 set in August of 1995 (peaking almost coincidentally with the Fool Portfolio buy). Doom and gloom filled the air -- fueled by a glut of semiconductors, rotten book-to-bill ratios, and overall pessimism about the stock and the semiconductor industry in general. The PE ratio on this stock had fallen below 10. Interestingly, the prior quarter earnings report had been the best in Applied Material's history.
With cyclical stocks, and Applied Materials is a cyclical growth stock, things are often darkest at peaks of earnings and begin to brighten as earnings news hits a nadir. Such is the case with Applied Materials -- the July quarter showed a decline in earnings versus the prior quarter and the stock started back up. In the conference call for the 1996 fourth quarter, Chief Executive Officer James Morgan commented that there were "rays of hope" for the company and semiconductor industry. He also expressed optimism for the fiscal year ahead. The stock took off and hasn't looked back. Incidentally, earnings for that fourth quarter, while estimate beating, were less than half of the earnings reported 2 quarters earlier. In the case of cyclical stocks, it is always darkest before the dawn.
Applied Materials is the world's largest producer of semiconductor fabrication equipment. This is the stuff used to manufacture semiconductor chips. Applied is one of the "tool and die" makers of the semiconductor industry. A description of its products can get to be fairly arcane for those who are not in the business. The company makes a wide variety of equipment that is used in almost every step of the semiconductor wafer fabrication process, including chemical vapor deposition, plasma etching, and ion implantation systems.
Some of its products include the Silicon Etch DPS (decoupled plasma source), the Centura etching systems, the DxZ Optima high throughput platform for CVD (chemical vapor deposition) and a series of additional intriguing machines. (Are you numb yet?)
Applied's machines perform 6 of the 8 basic semiconductor manufacturing steps giving it the most complete product line in the business. The company is in the process of developing methods for making higher-capacity chips more efficiently. In addition, Applied is developing active-matrix flat panel displays for use in laptop computers and high-definition TV.
Applied Materials is the undisputed leader in its business. The company does almost 4 billion dollars in annual sales and sells in all world markets. In the most recent quarter, 35% of revenues came from North America, 24% from Europe, and the remainder from the Far East. The company has also managed to expand gross margins over the past quarter, even in the face of declining revenues. In the first quarter reported on Feb.12, the company announced earnings of $0.48 per share, beating analysts' estimates by 4 cents.
In 1992 if you had purchased Applied Materials stock instead of that brand new 386 PC you craved, your investment would have appreciated over 800%. The Applied Materials story is one of tremendous growth and tremendous leadership. Chief Executive James Morgan is widely regarded as one of the bright lights of the semiconductor equipment industry.
Income Statement 12-month sales: $3940.1 million 12-month income: $457.6 million 12-month EPS: $2.49 Profit Margin: 16.4% (pre-tax) Market Cap: $9362.5 million Balance Sheet Cash: $369.4 million Working Capital: $1617.0 million Long-term Debt: $223.6 million Ratios Price-to-earnings: 20.5 Price-to-sales: 2.4
COULD THIS DOUBLE HAVE BEEN PREDICTED?
The answer in this case is "probably." The proper signs of cyclical low were all there. There was significant pessimism, but the company gave guidance of a turnaround to come. In a growth stock screen I ran in September, Applied Materials stood among the top 25 stocks. This screen looks for companies with strong historical revenue and earnings growth along with a low price/sales ratio (PSR). In September, the PSR on Applied was under 1.5. Here in Fooldom on Oct.11 in a commentary on the fourth quarter report, Tom Gardner wrote, "...the demand for personal computers, for email, great online content, and thus, memory chips will rise from the ashes. And Applied Materials, the world's leader... will shine with them.... [T]he strongest hands are getting in for the long haul, methinks."
On the other hand, in a Barron's article in November 1996 Erika Klauer, semiconductor industry analyst at Salomon Brothers, was quoted as saying that it remains "way too early" to buy shares of companies like Applied Materials because "they haven't seen the trough in valuations yet."
I guess it depends on which voices you decide to listen to. In September, Applied Materials was a contrarian pick. It takes a clear mind and a long view to step up to the plate when the "chips" are down.
WHERE TO FROM HERE?
Do you believe the semiconductor industry is going to continue its comeback? Was July a cyclical low or is this latest upsurge in Applied Materials too much, too soon? This Fool has no clue, but there are Fools who do have a better handle on this. They hang out on the Applied Materials message board and in the Semiconductor Industry area. Taking a long-term view, I see more semiconductors used in more places in the future. The semiconductor industry is a long-term growth story.
With a price/sales ratio of 2.4 and a YPEG of $57, the stock looks fully valued here. However, given the comments of management in the last quarterly conference call, I suspect estimates will be rising. Randy Befumo (MF Templar) speculated about the potential for $66 a share as full value for Applied Materials in his Feb. 12 Evening News commentary. I can't argue with that, but I don't see another double on the horizon. However, an investor with a long-term outlook should be a participant in the semiconductor industry. Applied Materials represents one of the high-quality, bedrock companies in the industry and warrants consideration by Foolish investors.
-Mark Weaver, MD (MF Uptrend)
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