What happened

Shares of semiconductor names Lam Research (LRCX -0.28%), Applied Materials (AMAT 1.46%), and Advanced Micro Devices (AMD -0.35%) were up strongly today before retreating somewhat with the overall market to a gain of 6.4%, 1.5%, and 2%, respectively, as of 12:44 p.m. EDT.  

Most tech stocks were up early today on the news of a drop in jobless claims, as well as the resignation of embattled U.K. Prime Minister Liz Truss after only six weeks on the job. However, these chip-oriented names likely surged higher due to Lam Research's earnings beat last night, as well as its commentary about 2023 that may have reassured some investors.

With semiconductor stocks having sold off much more than the markets this year, they rebounded strongly off oversold conditions.

So what

Coming into Lam's earnings report last night, each of these stocks were down more than 50% on the year. The two equipment companies, Lam and Applied, were trading at single-digit P/E multiples based on trailing earnings. AMD's multiple, while still around 25 times earnings, was still at a multiyear low.

Needless to say, there was a lot of negativity baked into these three stocks heading into Lam's earnings report. It had already been well known there has been an historic slump in PC unit shipments this year, with shipments tracking for a roughly 20% decline over last year -- a modern-day record.

On top of that, there was great uncertainty as to how new regulations governing advanced chip and equipment sales to China, which came out earlier this month, would affect these companies. Then, of course, there are fears the Federal Reserve may intentionally cause a recession next year with its rate increases to tame inflation.

Against that pessimistic backdrop, Lam Research delivered outstanding results, while also being realistic about next year's outlook. In the September quarter, revenue surged 17.8% to a record $5.07 billion, and adjusted (non-GAAP) earnings per share of $10.42 was a record for the company, beating expectations by $0.88. Not only that, but guidance for the December quarter of roughly $10 was well ahead of expectations as well, even though the current quarter is affected by the new China regulations.

That certainly seemed to show Lam is performing well; however, the big question comes next year, when the current weakness in chip sales will lead to softer investment. Management gave a preliminary outlook for overall 2023 industry spending, which it predicts will be down a little more than 20%. The decline will mostly come from severe cutbacks in memory spending, as well as the new China regulations.

While not great, the uncertainty around next year's semiconductor investment had been weighing on the stock, and those declines should mark a trough. So to have management give out a number perhaps helped investors get comfortable with where the next cyclical bottom will be.

This morning, a slew of Wall Street analysts actually came out and slashed their price targets on Lam based on that projection. Yet as is often the case with these tricky cyclical stocks, Lam's stock rose as the lowering of expectations helps investors get a sense of where the near-term trough in earnings may land.

Lam and Applied should still make material profits next year, even if equipment spending declines that much. Additionally, over 37% of Lam's revenue last quarter was from its services and spares business, which will be less volatile and tied to the installed base. Both stocks also generate good cash flows and should have the means to keep repurchasing stock and pay growing dividends through the downturn.

Now what

Semiconductors tend to have pretty abrupt downturns once every few years, so their stocks are not for the faint of heart or those who can't live with volatility. However, the long-term growth trend for leading semi stocks is up and to the right. In the prior downturn in 2019, these stocks bottomed in late 2018 and then actually rose much higher in 2019, even while earnings were bottoming throughout the year.

This is because the market is somewhat forward looking and also why they are bouncing hard off of Lam's guide for declines next year. On the flip side, you can see how these stocks crashed in 2022 well before earnings, which are actually still coming in strong through the end of this year.

Therefore, those interested in these beaten-up semiconductor stocks may wish to put some money to work now, rather than wait for their earnings to bottom out. These bargain-priced stocks could be much higher by that point.