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This Top Growth Stock Just Became More Affordable

By Harsh Chauhan - Feb 26, 2020 at 9:45AM

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The recent pullback in chip stocks has made Applied Materials cheaper than before.

Applied Materials (AMAT 2.51%) started 2020 with a bang, but the stock has pulled back of late. The impact of the coronavirus outbreak has forced major tech companies to slash revenue guidance, and this has weighed on chip stocks as well. But the pullback at Applied Materials could be an opportunity in disguise, as the stock is slightly cheaper now than it was at the beginning of the year.

AMAT Chart

AMAT data by YCharts

Applied Materials' latest quarterly results and guidance give out a clear indication that the impressive rally clocked by the stock last year is here to stay. Applied Materials was a top growth stock last year; it smashed the broader market's performance by a convincing margin even though its revenue and earnings were heading in the wrong direction.

And now that Applied Materials' top and bottom lines have started heading north, don't be surprised if the stock manages to improve upon its 2019 performance.

Person pressing the buy button on a keyboard.

Image Source: Getty Images.

What's working for Applied Materials?

Applied Materials' revenue shot up 11% annually during the first quarter of fiscal 2020 to $4.16 billion. Its net income jumped 16% thanks to a slight improvement in its gross and operating margins. CEO Gary Dickerson pointed out that the company was able to beat the high end of its own guidance range as well as Wall Street's estimates thanks to an uptick in its semiconductor systems business.

Applied Materials gets over 68% of its revenue by supplying semiconductor fabrication equipment to chipmakers. Revenue from this business was up 24% annually during the recently reported quarter, and the good news is that the company expects the momentum to continue. Applied Materials expects a 40% annual jump in its semiconductor systems business this quarter, thanks to a slew of growth drivers in the foundry logic business that accounts for 68% of revenue of the semiconductor systems division.

Dickerson explained this on the latest earnings conference call:

Moving to our near-term outlook, we see robust foundry logic investment continuing. There is a strong commitment on the part of these customers to advance the leading edge as they get ready for demand related to the rollout of 5G. At the same time, we're also seeing healthy spending for specialty nodes to support growing demand from the IoT, communications, automotive, power and image sensor market.

As it turns out, demand for semiconductors is anticipated to increase this year. World Semiconductor Trade Statistics predicts a 6% increase in semiconductor sales this year after last year's drop of nearly 13%. More importantly, the deployment of new technology such as 5G (fifth-generation) wireless networks will force chipmakers to invest in new equipment.

Gartner estimates that 5G infrastructure investments could rise from $2.2 billion last year to nearly $4.2 billion in 2020. It is not surprising, then, to see why Applied Materials is counting on 5G as an important growth driver this year.

Meanwhile, the other components of the semiconductor systems business should also make a comeback in 2020. Applied Materials relies on DRAM (dynamic random access memory) and flash memory for the remaining revenue within its semiconductor systems business. These two businesses were in bad shape last year thanks to an oversupply.

But things are looking up in the memory market now. Recent supply chain checks indicate that the DRAM market could move toward an undersupply that may last for two years. Meanwhile, NAND flash prices are already on the rise and are expected to jump as much as 40% in 2020, according to third-party estimates.

So, memory industry participants could gradually increase their capacities and create a tailwind for Applied Materials.

A good time to buy

Applied Materials' outlook indicates that it expects its top-line growth to gain solid momentum this year. The company expects $4.34 billion in revenue during the current quarter, a jump of 22% from the prior-year period. It expects earnings to jump from $0.70 per share last year to a range of $0.98 to $1.10 this time.

What's more, Applied Materials anticipates "strong double-digit growth" in the semiconductor business this year, and that should have a positive impact on the company's overall financial performance. And finally, the stock isn't too expensive considering its rally over the past year and the potential growth on offer.

Applied Materials stock trades at 20 times trailing earnings, which is a tad higher than the five-year average multiple of 17.6. A forward earnings multiple of 16 times indicates potential bottom-line growth. All of this means that investors should continue to hold Applied Materials stock despite its terrific run over the past year, as it seems primed for more upside.

Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool recommends Applied Materials and Gartner. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Applied Materials, Inc. Stock Quote
Applied Materials, Inc.
$108.66 (2.51%) $2.66
Gartner, Inc. Stock Quote
Gartner, Inc.
$312.45 (-0.51%) $-1.59

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