As investors, it's sometimes helpful to trace down all of the inputs of a value chain for a particular product. This especially rings true for a huge movement like artificial intelligence (AI), as there are many ways to capitalize on this movement.
So, let's look at the AI value chain and see which company is at the heart of this movement.
ASML is a key part of AI
When investing in AI, it's easy to find companies providing AI-based products to customers. These software companies and their clients use data centers filled with high-powered graphics processing units (GPUs) to crunch mountains of data to inform these AI models.
But what goes into the GPUs that power AI? Well, the best-in-class GPUs produced by Nvidia are powered by chips made by Taiwan Semiconductor Manufacturing. These chips are incredibly small and pack transistors into areas as dense as one unit per three nanometers. For reference, a human hair is anywhere from 80,000 to 100,000 nanometers wide. That's an incredibly small area to work with, requiring extremely specialized equipment to do the job.
One of those equipment manufacturers is ASML (ASML 2.04%), a Dutch equipment manufacturer specializing in producing extreme ultraviolet systems. These machines transfer the chip pattern onto a silicon wafer and are necessary to produce powerful chips that go into various products.
This technology has only been developed and produced by ASML, giving it a de-facto technological monopoly. As a result, investing in ASML is quite lucrative, as the competition is nonexistent for a must-have product for chip manufacturers.
Its financials also make it a solid buy, too.
Consider a long-term perspective on Q3's weak orders
ASML's financial results are quite lumpy, as a single machine costs several million dollars, and having an extra system or two sold in one quarter versus the next can affect the analysis. As a result, investors should focus on long-term trends and other forward-looking metrics like bookings and backlog.
In the third quarter, ASML added 2.6 billion euros (roughly $2.85 billion) to its net bookings, which was drastically smaller than the second quarter's 4.5 billion euros. However, management urged investors to ignore that figure, as its total backlog is over 35 billion euros. For reference, ASML had 5.3 billion euros in system sales in Q3, so this backlog represents about seven quarters' worth of business. Investors will need to watch this trend over the next few quarters to ensure that this weak bookings figure doesn't continue, but the overall landscape is still positive for ASML.
As for the stock, it's valued at a premium for two reasons. First, ASML is the only company that does what it does. Second, it has executed at high levels for a long time, so it has also earned a premium in that respect. Combine those two factors, and you have a stock that could reasonably trade at a price-to-earnings (P/E) ratio that many deem too expensive.
However, ASML's current P/E ratio isn't that bad, especially considering many tech giants have a similar valuation.
ASML PE Ratio data by YCharts
Furthermore, 34 times earnings is much cheaper than the stock has been in recent years, so investors shouldn't feel uncomfortable with the premium they have to pay for ASML, especially considering its dominance and track record.
With many chip companies ramping up production to meet AI-related demand, ASML looks to be a prime benefactor. With the stock trading at a reasonable valuation for its pedigree, it looks like a strong buy.
