The global chip shortage started after the onset of the COVID-19 pandemic in 2020. Companies are still struggling to get enough computer chips for their products to meet customer demand. This industry disruption, along with the 2022 bear market, has wreaked havoc on semiconductor stocks. For reference, the iShares Semiconductor ETF (SOXX 2.10%) is down 38% year to date.
But among the wreckage and supply chain woes are some wonderful investment opportunities. Here's why Applied Materials (AMAT 2.94%) is a monster opportunity for investors amid this global chip shortage.
Selling the machines that make the machines
Building modern computer chips is a complicated process. Manufacturers like Intel and Taiwan Semiconductor Manufacturing need insane levels of precision, efficiency, and technological know-how to put so much computing power onto tiny little semiconductor wafers. This is where Applied Materials steps in. The company sells machines that manipulate materials on an atomic level and an industrial scale for chipmakers. In fact, according to Applied's website, its machines and other engineering solutions help build virtually every computer chip and advanced digital display in the world.
Applied has decades of experience within this market, spending $2.7 billion on research and development over the last 12 months alone. This huge amount of R&D spending -- which has been consistent over the decades -- gives Applied a technological lead that no company can match within its equipment niches. What this means is that chipmakers have to buy equipment from Applied Materials if they want to continue building advanced computer chips for their customers. There are no other options.
The problem is, with the surging demand for semiconductors around the world, Applied has been unable to make enough machines for its customers, who are therefore unable to fulfill the customer demand for companies like Apple or Nvidia. This bottleneck is one of the key reasons for the global chip shortage the industry is currently enduring. And while Applied Material's revenue hit a record high of $25.2 billion over the last 12 months, management said it would be even higher if it was able to build more equipment for manufacturers.
Customers have huge expansion plans
Applied's equipment shortage should ease once it is able to get enough parts from all of its suppliers. It might take a few years instead of a few quarters, but there's no reason to think it won't get solved eventually.
Whenever the company's supplies open up, there is a huge amount of demand to be filled by its largest customers. Taiwan Semiconductor Manufacturing is planning on spending $40 billion to $44 billion on capital expenditures in 2022. It is also building a new $12 billion advanced chipmaking facility in Arizona. Intel is planning on spending $40 billion across the United States to build new factories and says it plans to spend $77.5 billion in Europe over the next decade. A lot of this money will be spent on getting semiconductor manufacturing equipment, which should benefit companies like Applied Materials.
This tailwind, which should accelerate as supply chain bottlenecks abate, will bring Applied Material's revenue to new heights within the next five to seven years.
What about the valuation?
As of this writing, Applied Materials trades at a market cap of $74 billion. Over the last 12 months, it has generated a net income of $6.6 billion, giving the stock a trailing price-to-earnings ratio (P/E) of 11.2, which is well below the market average of 18.9.
Remember that these earnings numbers are suppressed because of the chip shortage. If the demand from manufacturers remains, Applied's revenue and net income should soar over the next few years, bringing its P/E well below 10 based on its current share price.
AMAT Shares Outstanding data by YCharts.
What is the company doing with all these profits? Returning cash to shareholders through share repurchases. Applied's shares outstanding are down 28% in the last 10 years, which helps earnings per share grow even faster than nominal net income.
All these factors make Applied Materials stock a great buy at these prices.
