Missed Out on Nvidia? My Best Semiconductor Stock to Buy and Hold

Nvidia's stock price was cut in half this year as rising rates drove investors away from higher-growth tech stocks. But over the past 10 years, Nvidia's stock still delivered a total return of nearly 4,500% -- making it one of the semiconductor sector's greatest growth plays.

Nvidia will likely continue to sell more GPUs to the gaming and data center markets, but analysts expect its growth to cool off over the next few years as those markets mature. Therefore, investors looking for a more promising semiconductor growth story should check out ASML Holdings (ASML 1.14%), a Dutch company that trades at roughly half of Nvidia's market cap.

Image source: Getty Images.

A linchpin of the global semiconductor market

ASML is the world's largest producer of photolithography systems, which are used to etch circuit patterns onto silicon wafers. It's also the sole producer of extreme ultraviolet (EUV) lithography systems, which are required to manufacture the smallest and densest semiconductors.

ASML's EUV systems cost about $200 million each and require multiple planes to ship. Its top customers include Taiwan Semiconductor Manufacturing, Samsung, and Intel, which are currently locked in a costly "process race" to produce the world's most advanced chips. All those leading foundries need to procure an increasing number of EUV systems from ASML to win that race.

ASML is now gradually rolling out its next-generation "high NA" EUV systems, which cost about $300 million each, to enable chipmakers to manufacture even smaller chips beyond the smallest 2nm node. In other words, ASML has become a linchpin of the semiconductor market -- and it doesn't face any meaningful competitors in its capital-intensive niche.

Stable growth with expanding margins

ASML's growth is cyclical, but its gross margins have consistently expanded over the years as it has maintained its near-monopoly, exercised its pricing power, and sold a higher mix of higher-margin EUV systems.

Source: ASML. YOY = Year over year.

ASML expects its annual revenue to rise "around 20%" in 2022, then grow to 24 billion to 30 billion euros ($31.3 billion) by 2025. Those estimates, which are modeled after "low" to "high" expectations for the global semiconductor industry, would translate to a compound annual growth rate (CAGR) of 6.6% to 12.7% between 2021 and 2025. It expects its gross margin to expand to 53% in 2022, and eventually reach 54%-56% by 2025.

ASML also expects its top line to grow at an average rate of 11% between 2020 and 2030, which implies its revenue could approach 50 billion euros ($52.1 billion) -- nearly triple its revenue in 2021 -- by the end of the decade. It expects most of that growth to be driven by its EUV and high-NA systems.

ASML has a history of sandbagging its long-term forecasts, and these latest estimates (which it presented last September) could be quite conservative. By comparison, Future Market Insights recently predicted that the EUV market could actually grow at a CAGR of 21.5% between 2022 and 2029, driven by the secular expansion of the artificial intelligence (AI), machine learning, industrial Internet of Things (IIoT), and connected vehicle markets.

Shareholder-friendly strategies and a reasonable valuation

ASML also consistently returns a large portion of its free cash flow (FCF) to its investors through buybacks and dividends.

Image source: ASML.

It plans to maintain those shareholder-friendly strategies for the foreseeable future, and it pays a decent forward dividend yield of 1.3%. The stock might not seem cheap at 30 times forward earnings and eight times this year's sales, but I believe its aforementioned strengths justify those higher valuations.

ASML's stock will likely be weighed down by the gloomy expectations for the semiconductor sector this year. But over the long term, I believe it could still easily generate multibagger returns for patient investors.