What happened
Lam Research's (LRCX 2.65%) stock price dropped by 10.5% in September, according to S&P Global Market Intelligence. The semiconductor sector's rally cooled off last month, with investors focusing on news that indicates demand for chips is weakening. As an important supplier to chip makers, Lam Research was a victim of those broader trends.
So what
Lam Research manufactures and services equipment that's used in semiconductor fabrication. Its customers include some of the world's highest-profile chipmakers, including Taiwan Semiconductor Manufacturing (TSM 1.26%) and Intel (INTC -9.20%). As a result, Lam Research's stock tends to rise and fall with the sector, even if there's no notable news about the company itself.
September was an active month for semiconductor stocks. Taiwan Semiconductor, the world's largest contract chip foundry, reported that its sales were down 13% year over year in August despite hitting the highest level since January. In addition, in mid-September, it was reported that Taiwan Semiconductor had asked its suppliers to temporarily delay delivering some orders of high-end chipmaking equipment. That suggested weaker-than-expected demand in the chip market, and it created jitters among investors about the industry's near-term prospects. Those fears appeared to be confirmed at least partially at Intel's September investor event, during which the CFO spoke about some short-term challenges. Investors weren't pleased with those comments, driving shares lower.
Image source: Getty Images.
None of this necessarily means that Lam Research is bound to report disappointing results, so the market could be overreacting. However, Lam's financial results tend to reflect the cash flows throughout the semiconductor industry supply chain. In the absence of company-specific news, it's fair to expect investors to respond to new sectorwide information. That's especially true when that news directly reflects the prospects for Lam's biggest customers.
Now what
Lam Research is a wide-moat operation that enables a well-established industry with strong long-term growth catalysts. Lam doesn't have incredible growth potential itself, but it is in a phenomenal position to enjoy many years of steady and modest cash-flow expansion. That's a strong foundation for shareholder returns, and it means that the stock is worth a look for any investor.
Despite its recent pullback, Lam Research trades at a forward price-to-earnings ratio above 23. That's still close to an all-time high for this stock. But it's not prohibitively expensive, especially when compared to other high-growth sectors. However, investors should recognize what that means for its volatility and return potential. This isn't a stock that the market has overlooked, and it's not likely to generate meaningful returns from investor hype and attention. In fact, the valuation makes it more likely that the stock will endure elevated volatility if investors are surprised by the timing or severity of a cyclical pullback in the semiconductor industry. Bullish investors need to focus instead on the company's ability to deliver strong cash flows over the long term.
