Warren Buffett turned heads last week when he invested in a semiconductor stock for the first time, foundry giant Taiwan Semiconductor Manufacturing (TSM 1.63%).

While the Oracle of Omaha had lots of good reasons to invest in TSMC, there might actually be a greater opportunity in Taiwan Semi's key suppliers, like these three profitable semiconductor equipment stocks.

Applied Materials

As Taiwan Semiconductor has a highly diverse set of powerful customers, so does Applied Materials (AMAT -0.47%). Applied Materials is the largest semiconductor equipment stock by revenue, and serves the advanced foundry/logic, trailing-edge foundry/logic, DRAM and NAND memory, advanced display, and advanced packaging markets.

While the market is generally downbeat on the semiconductor sector in the near term, Applied Materials just crushed estimates on its recent earnings release, all while displaying a record backlog going into next year.

How is that possible? Well, Applied's machines are heavily skewed toward the logic and foundry sector, which seems to be more resilient in terms of investment then the more problematic memory sector. In its recent quarter, DRAM and NAND flash memory sales only encompassed 29% of Applied's systems sales. Therefore, even if those segments decline significantly next year, Applied should be able to maintain good sales and profits, even in the softer part of the semiconductor cycle.

Meanwhile, memory sales are an even lower percentage of overall sales, as Applied's services business made up just over 21% of sales last quarter. That segment of the business consists of spare parts, service, as well as recurring subscriptions tied to value-add services for clients, and should be less volatile than system sales. In fact, management projects the services segment will continue to grow next year, even if systems sales decline, due to the much larger installed base after the last two blockbuster years.

Despite inflationary pressures, Applied Materials has maintained high profitability, with about 30% operating margin over the past two years. AMAT has also been very generous to shareholders with those profits, returning nearly $7 billion to shareholders through share repurchases, retiring 6% of Applied's shares outstanding over the past year.

The foundry and logic space appears to be on solid footing, given the technology transitions to AI and electrification, competition among the world's foundries to provide leading-edge capabilities, and the reshoring of manufacturing activities in developed countries all over the world. With a foundry-focus and a resilient high-margin services business, Applied Materials is a solid cash generator at a cheap valuation, like TSMC.

ASML Holdings

For more growth-oriented investors, ASML Holdings (ASML -0.05%) is a similar bet to Applied Materials, but appears to have more consistent year-to-year growth prospects. That has made ASML a more expensive stock than Applied, with a larger market cap despite lower revenues; however, ASML has a monopoly on key extreme ultraviolent lithography (EUV), which is the enabling technology of leading-edge nodes at or below 7nm, and it has a dominant position in deep ultraviolet lithography (DUV) for lagging-edge nodes.

EUV just came into use for foundry/logic a couple years ago, and is only now just being implemented for DRAM memory, so it has years of consistent and profitable growth ahead of it, which is why ASML is more of a consistent grower than its more cyclical peers.

In fact, ASML just raised its longer-term revenue and profit outlook through 2025 and 2030 at its recent investor day, despite the softer semiconductor market in 2023. For much of the reasons that Applied Materials' foundry sales continue growing, ASML increased its outlook and thinks it will grow even next year. When asked, management said that the lead times for its backlog were actually likely longer than any upcoming recession.

Again, ASML noted increased semiconductor content demand due to the larger projected market for servers, particularly for compute-heavy artificial intelligence and the buildout of the metaverse, which requires more of the most advanced high-performance chips, along with the ongoing electrification of vehicles and the buildout of a smart electrical grid, which is reigniting growth of lagging-edge chips.

Beyond the increased long-term growth of semiconductors, the buildout of foundries in the U.S. and Europe for security reasons could also make the foundry ecosystem less efficient, perhaps leading to 10% more equipment sales than would be the case if chip production were as concentrated as it is now in Taiwan.

That "tech sovereignty" inefficiency is another reason these equipment suppliers may have even better long-term growth prospects than foundries such as Taiwan Semi.

Kulicke and Soffa

If ASML may be the "growth-ier" pick for investors, wire bonding and advanced packaging leader Kulicke and Soffa (KLIC) may be the better pick for value investors who want to buy lower-valued stocks.  

Kulicke and Soffa's operating results are much more cyclical and volatile than either Applied Materials and ASML; however, the stock can also be had at a much lower valuation. Currently, K&S trades at just 6.3 times earnings. In addition, K&S has a robust $775 million cash position and no debt, making up about 28% of that already-low market cap.

There is a reason K&S is so cheap. Even though it just reported a quarter that beat analyst expectations last week, K&S guided to a big decline in revenue and earnings in the upcoming quarter, as its assembly and-test and foundry customers pause their buying to digest the capacity they've bought over the past couple years. Management now projects revenue to decline from $286 million last quarter to $175 million in the December quarter, with adjusted (non-GAAP) earnings falling from $1.19 to about $0.20. In its past fiscal year, Kulicke and Soffa earned an all-time high $7.45 per share as sales and earnings boomed.

However, even in the upcoming down year, management believes its sales and earnings will either match or exceed the prior peak from fiscal 2018. This is because the longer-term outlook for advanced packaging is bright. Over the past decade, the front-end equipment companies like Applied and ASML saw sales grow as the intensity of front-end investment grew to shrink transistor distances further and further. Going forward, foundries like Taiwan Semi and others will rely more on advanced packaging techniques to continue making chips and systems-on-chips more powerful and energy-efficient, as merely shrinking transistor distances becomes harder. 

K&S management has done a great job expanding its product capabilities over the past five years under CEO Fusen Chen, both through internal research and bolt-on acquisitions. The company has strengthened its leading position in the traditional ball bonder packaging equipment market, which it dominates, while also developing new markets in advanced packaging, electric vehicle battery assembly, and advanced displays. That should enable K&S to reach higher highs and lows with each cycle.

Like Applied and ASML, Kulicke and Soffa has also been repurchasing its stock during this downturn. But thanks to its super-low valuation, K&S was able to repurchase nearly 10% of its shares over the past 12 months, and it just raised its 1.6% dividend despite the upcoming downturn. It's a very cheap way to play exciting new chip innovation.