When a company like Nvidia (NASDAQ: NVDA) becomes a popular artificial intelligence (AI) stock pick, it becomes difficult to invest in the company due to an inflated stock price. When that happens, it's best to look a few levels down in the supply chain and examine some other winners.
A hardware company like Nvidia has multiple suppliers it utilizes to bring its best-in-class products to market. One key company in its supply chain is ASML (ASML 2.04%): Its extreme ultraviolet (EUV) lithography systems are required to produce the world's most transistor-dense and powerful chips, such as those that go into the Nvidia GPUs designed for training AI models.
So should you invest in ASML?
ASML has products no one else has
ASML has earned itself a monopoly on its EUV systems. No other company can produce machines that replicate what its machines do (although Huawei has filed a patent for a similar process). Because of that, ASML has no competition.
Furthermore, the machines take years to build and are about the size of a school bus. And in a market where demand for high-end chips is strong, its lithography systems more or less sell themselves.
However, the Dutch government has put some limits on where ASML can sell its products.
Because ASML is based in the Netherlands, it's subject to other guidelines. Still, that nation's goals are mostly aligned with those of the U.S. and the E.U., and it aims to ensure certain countries -- prominent among them, China -- can't purchase this cutting-edge technology. Sales of EUV systems (its most powerful variety) have been restricted since 2019. Additionally, the Dutch government has begun to restrict sales of ASML's deep ultraviolet (DUV) machines, which are used to manufacture less powerful but still important chips.
ASML now must apply for export licenses for its DUV lithography machines to ensure these products aren't going to China. Fortunately for investors, ASML doesn't expect these restrictions to materially affect its business this year or in the foreseeable future.
So even though ASML is unable to sell into a meaningful section of the global market, it still can be a strong business.
But just how good are ASML's financials?
An expensive stock that has earned its high valuation
ASML's revenue rocketed 91% higher year over year in Q1 to 6.75 billion. That strength is expected to continue, with sales projected to rise 24% in Q2.
Notably, ASML only sold 100 lithography systems in Q1 to bring in that 6.75 billion euros -- reflecting just how valuable its products are.
ASML is also quite profitable: Its 29% net income margin is top-tier for a hardware company. This profit margin generates loads of cash for ASML, which it has used to reward shareholders by repurchasing stock (about 2% of shares outstanding last year) and paying dividends. However, at the current share price, its payout only yields 0.8%.
ASML PE Ratio data by YCharts.
As for valuation, ASML is not a cheap stock, nor will it ever be one.
Because it has a lock on the EUV market, it carries a premium valuation. However, its current and forward price-to-earnings ratios are above where the company has historically traded. Part of this premium is due to the surge in interest around AI technology, as more ASML machines will be required in order for chipmakers to fulfill the AI-driven demand for processing power.
So is ASML a good stock to buy now? I'd say it is. Its monopoly in an important market puts it in an enviable position. While the stock may be expensive, investors often have to pay a premium to own best-in-class businesses, which is what ASML is. While this may not be a stock to go all-in on, it is a great growth stock that could balance out some of the high-flying but unprofitable businesses in your portfolio.
