What happened
Applied Materials (AMAT -1.65%) stock was a big winner in 2021, rising 82.3%, according to data from S&P Global Market Intelligence.
Applied is the world's largest and most diversified semiconductor equipment company by revenue. Since there was a huge chip shortage last year, Applied rode a wave of strong results as chipmakers scrambled to purchase machines to increase supply.
Even though the threat of rising rates hurt a lot of tech stocks toward the end of the year, Applied's terrific cash generation and quite reasonable valuation allowed it to weather those headwinds.
Image source: Getty Images.
So what
Applied Materials posted strong growth all through 2021, beating analyst expectations every quarter, except in its most recent earnings report in November. However, that miss was purely due to supply chain constraints plaguing a variety of industries, not demand. After a short drop, the stock soon recovered as investors likely realized those sales would be deferred into next year and not lost.
In its fiscal year ending in September, Applied posted 34% revenue growth, 62% operating income growth, and a whopping 64% increase in earnings per share. So even though Applied's stock went up so much, its P/E ratio only slightly expanded. And Applied still only trades around 18.2 times 2022 estimates -- below the multiple of the overall market.
AMAT PE Ratio data by YCharts
Why the discount, for such a strong grower? Well, the semiconductor equipment industry has traditionally been highly cyclical, prone to booms and busts based on how the overall economy and chip demand are doing. Therefore, many investors may be unwilling to bid Applied and its peers up to a high multiple due to fears over the next downturn.
However, while it's always dangerous to say, "this time is different," some analysts believe we are entering a new era of computing, which will make semi equipment growth steadier and more robust compared with the past. That could lead to even further valuation expansion.
Analysts at Jefferies recently initiated Applied at a buy rating, with a $197 price target -- about 33% higher than today's price. The analysts wrote, "We believe that the computer industry is transitioning from a cellphone / serial processing era, with billions of cellphones, to an IoT [Internet of Things] / parallel processing era, with tens of billions of IoT devices made with chips on trailing nodes."
So demand is strong not only for leading-edge chips for 5G and artificial intelligence, but also trailing nodes for the Internet of Things and connected car applications. As a highly diversified equipment supplier, Applied Materials stands to benefit from all of those segments, which should even out its results.
Now what
While the risk of a down cycle is always present, and investors should be mindful of it, Applied has a lot of qualities to like over the long term, including the secular growth of semiconductors, limited competition, and high returns on capital.
In 2022, Applied and its peers seem poised for yet another year of growth, given that we are still in the thick of a chip shortage and many customers have already pre-booked equipment sales for this year. That would mark three straight years of solid growth for Applied and the industry.
If the industry is still cyclical, then 18 times forward earnings might seem fair. But if it is now a steadier growth industry, Applied's stock price is still too low, despite its outsize gains in 2021.
While I was fortunate to own Applied Materials stock over the past couple years of growth, I'm also not eager to sell shares anytime soon.
