Applied Materials' (AMAT 1.35%) stock price soared to an all-time high of $167 back in January. At the time, investors were convinced the semiconductor equipment maker would be a great long-term play on the ongoing chip shortage. But today, Applied Materials' stock only trades at about $110 a share.

Let's dig deeper into Applied Materials' business model, growth rates, and valuation to see if it's worth buying again after that steep pullback.

A silicon chip wafer.

Image source: Getty Images.

What does Applied Materials do?

Applied Materials provides a wide range of equipment, services, and software for manufacturing semiconductors, display panels, solar products, and coatings for flexible electronics.

It's one of the world's largest semiconductor equipment makers alongside ASML Holding (ASML 2.35%), Tokyo Electron (TOEL.Y -0.43%), and Lam Research (LRCX 1.30%). These companies all provide the crucial "picks and shovels" of the semiconductor industry.

Applied Materials generated 71% of its revenue from its semiconductor systems business in fiscal 2021, which ended last October. This segment primarily provides equipment for foundry, logic, and memory customers.

The company generated another 22% of its revenue from its applied global services business, which installs and maintains those systems, and the remaining 7% from its display and adjacent markets business, which provides manufacturing equipment for LCD and OLED screens.

How fast is Applied Materials growing?

Here's how Applied Materials' three core businesses fared over the past four years.

Metric

FY 2018

FY 2019

FY 2020

FY 2021

Semiconductor systems revenue growth

15%

(15%)

26%

43%

Applied global services revenue growth

24%

3%

8%

21%

Display and adjacent markets revenue growth

31%

(28%)

(3%)

2%

Total revenue growth

19%

(13%)

18%

34%

Data source: Applied Materials.

Its semiconductor systems business suffered a slowdown in fiscal 2019 as the memory market struggled with a global supply glut. That cyclical downturn was primarily caused by slowing sales of smartphones. Soft sales of smartphones and TVs also dragged down the display market that year.

Both businesses recovered over the following two years as new 5G phones and OLED devices hit the market. Remote work and stay-at-home trends during the pandemic also boosted sales of new PCs, data center chips, and TVs, while the ongoing chip shortage amplified that demand.

But in the first half of fiscal 2022, Applied Materials' revenue only increased 16% year over year as the pandemic-induced tailwinds faded. With the PC, data center, and smartphone markets cooling off, analysts expect Applied Materials' revenue to rise just 10% for the full year and 8% in fiscal 2023.

How profitable is Applied Materials?

Applied Materials is profitable by both generally accepted accounting principles (GAAP) and non-GAAP measures. Let's take a closer look at its non-GAAP margins and earnings-per-share (EPS) growth:

Metric

FY 2018

FY 2019

FY 2020

FY 2021

Gross margin

46.1%

44%

45.1%

47.5%

Operating margin

28.1%

23.5%

26.3%

31.7%

Year-over-year EPS growth

37%

(27%)

37%

64%

Data source: Applied Materials.

Applied Materials' gross and operating margins have consistently expanded since its previous cyclical downturn in fiscal 2019. That ongoing expansion, which we've also seen at its industry peer ASML, indicates that semiconductor equipment makers gained a lot of pricing power as the chip shortages and supply chain disruptions dragged on.

But as that demand wanes, Applied Materials' margins will likely contract as its earnings growth decelerates. Analysts expect its adjusted operating margin to dip to 30.5% this year, then rebound to 30.9% in fiscal 2023. They forecast its adjusted EPS to grow 9% this year and 12% in fiscal 2023.

Is Applied Materials worth buying?

Applied Materials faces a cyclical slowdown, but its stock trades at just 13 times forward earnings after tumbling 30% so far this year. It also pays a decent forward dividend yield of just under 1%.

That multiple makes Applied Materials seem a lot more reasonably valued than ASML, which still trades at over 40 times forward earnings. ASML attracts more attention because it dominates the crucial high-end photolithography system market, but it still faces many of the same cyclical headwinds.

Applied Materials' downside could be limited at these levels, but it also doesn't have that much upside potential. It doesn't monopolize a crucial sector like ASML, but its stock also isn't as cheap as other beaten-down semiconductor plays like Micron. Based on these facts, I wouldn't be in a hurry to buy Applied Materials.