Most of the semiconductor industry is in a deep slump (with an obvious exception being Nvidia. In fact, the current downturn that cropped up late in 2022 and that seems to finally be finding a bottom is one of the worst ever for the chip industry -- an aftereffect of massive spending on electronics during the pandemic, followed by a steep decline in spending as global supply chains normalized.
The downturn was especially bad for the sensitive memory chip market. Some investors placed their bets on U.S. memory manufacturing leader Micron Technology (MU 2.92%), owing to the growing importance of memory chips in AI applications and funding from the U.S. CHIPS Act. But there's one other top stock that could be an even better investment in a memory rebound: Lam Research (LRCX 2.65%). Here's why.
Lam management charts a profitable course in dangerous territory
Lam Research provides equipment and process technology for companies that manufacture semiconductors. Historically, Lam has tilted heavily toward the memory chip portion of this market and has done an exceptional job of consistently pulling profit from the most volatile part of the semiconductor industry. Just look at Lam's generally accepted accounting principles (GAAP) net income and free cash flow versus that of a customer like Micron.
Data by YCharts.
Lam's consistency is thanks to its deep expertise in the expensive equipment required to make chips, as well as the oligopoly on this market it shares with what I call the "fab five" -- the five dominant companies in wafer fab (a facility that makes silicon wafers, which eventually get diced into chips) equipment, ASML, Applied Materials, Tokyo Electron, KLA, and Lam.
However, Lam's slump has been quite steep versus some of its peers, again owing to its outsized reliance on memory. Though revenue began to tick higher each quarter as 2023 progressed, Lam is still lapping record equipment sales in 2022, followed by the implosion in electronics demand of 2023. For the quarter ended in September 2023, Lam reported a 31% year-over-year decline in revenue to $3.48 billion.
Despite the steep fall, though, Lam remained highly profitable all year at well over 20% operating margin. In fact, as quarterly sales begin to tick higher again, Lam is again approaching operating income margins of 30% (29.4% last quarter). Talk about a winning business model.
Doubling down on next-gen tech in 2024
It's now been loudly broadcast that global semiconductor sales are headed a lot higher through the end of this decade (expected to rise some 80% and reach $1 trillion annually by 2030). The digitalization of things like cars and the advent of giant computing systems in data centers to power AI will be key areas fueling these secular growth trends.
But underlying all of that are new chip technologies. Things like 3D architecture in memory (HBM3, or high-bandwidth memory, in AI applications) and backside power delivery in logic chips (used to continue to shrink down the size of computing systems) are all up-and-coming manufacturing tech that Lam plays a role in developing.
Investments into further research and development will be needed for Lam to keep pace with customer demands and with co-developments with the other four of the "fab five." Thus, Lam's management told shareholders on the last earnings call that it will elevate its spending on R&D in 2024 as revenue rises. Expect a possible pause in profit margin increases as a result.
As in times past, though, this spending into new manufacturing methods will pay off, and Lam expects it will be able to continue stacking growth and higher profits long-term.
A best memory market recovery stock?
The semiconductor industry, including memory chipmakers, is retooling for the next wave of demand. After a solid rebound for Lam stock this past year, things could get a bit bumpier in 2024 as management invests in its future.
That said, shares appear reasonably valued, though not a cheap stock by any means, at 22 times the current fiscal year (which ends in June 2024), expected earnings per share (EPS), and 17 times the expected fiscal 2025 EPS.
However, Lam sweetens the deal by returning ample amounts of cash to shareholders via a rising dividend and stock repurchases. In fact, Lam has historically done a great job on those repurchases by buying when the stock price is down.
Data by YCharts.
If you're looking for a top way to play the rebound in memory chips in 2024 and 2025, Lam Research should rank high on your list. This has been a market-beating investment for a long time and has all the right things going for it to continue as a best-in-class stock going forward.
