There are arguments to be made for investing in multiple facets of the artificial intelligence (AI) supply chain. There is the data collection side, data center suppliers, software applications, or hardware plays that can all make sense to invest in. However, these areas require semiconductors to power them. Not just any chip will do since the sheer amount of data in these workloads requires the most powerful chips on the planet to run them efficiently.
Making these chips is incredibly complex, and there are a few processes that require specific machines. One of these processes is EUV (extreme ultraviolet) lithography, and only one company in the world makes these machines: ASML (ASML 2.04%). So, is this the most important company in the AI chain?
ASML machines are in a class of their own
EUV lithography is needed to pattern the smallest features on chips. This allows semiconductor foundry companies to pack more transistors onto a chip, thus increasing its power and efficiency. These machines are incredibly complex and are about the size of a bus. This complexity is partially why ASML has maintained its monopoly on this field, and ASML is taking steps to ensure it doesn't lose it.
Even though nobody has the same technology as ASML, it's already working on its next-generation EUV machine. This will allow clients to create 2 nanometer (nm) or smaller chips and the first machines are slated to ship out in 2023 for research purposes, with expected full-scale production by 2025.
Without ASML's machines, AI models would have to be created with far less powerful chips, which may make the infrastructure too expensive to build or maintain. As a result, ASML is likely the most important supplier in the AI supply chain. But does it make sense to invest in it?
The stock is at a premium -- but for good reason
Because ASML's machines are incredibly costly, its quarterly results can be quite lumpy, as a few orders can sway results. For example, in the second quarter, ASML sold 107 new units and six used ones for a total of 5.6 billion euros. It also booked another 4.5 billion euros in future orders, so business appears to remain strong as the next generation of chip technology is developed.
ASML produced strong profits from those sales, turning its 6.9 billion in total revenue into 1.9 billion in profits -- a 28% profit margin. With those profits, ASML has paid a small dividend (currently sporting a 1% yield) and repurchases its stock regularly. A consistent performance like that, combined with its technological monopoly, earns ASML a valuation premium.
ASML PE Ratio data by YCharts
At 32 times trailing earnings, ASML is still above its historical levels and comparatively expensive to the market (which trades at around 25 times earnings). However, with AI likely causing a chip arms race and the company's strong execution, it makes sense that ASML is valued at a premium to the broader market.
While ASML isn't going to provide flashy returns like other companies in the AI field, it will provide consistent results. With high-end chip technology only expected to increase in our lives, ASML seems like a great candidate for a long-term investment. As long as ASML maintains its technology lead over others in this space (which it has done for some time), it should continue to be a fantastic market-beating investment.
