The market has been infatuated with Nvidia for a few years now. So much so that this month, it has once again become the largest company in the world by market capitalization, with a net worth of more than $3.5 trillion. The artificial intelligence (AI) boom has been a huge benefit to the business, and with the stock up more than 10x in just a few short years, it would be understandable for investors who didn't get in earlier to think they missed the boat.
So what's an investor to do now if they want to open a new position that will let them ride the AI wave? One promising AI stock that has taken a tumble this year is Applied Materials (AMAT 1.11%). The semiconductor equipment maker is getting hit due to a slowdown in sales to China, but smart investors will know that this is just a temporary headwind for a business with a wide moat. Here's why now is the time to buy the dip on Applied Materials.
Applied Materials: The machines that make the machines
Many investors know by now that Nvidia -- like numerous other companies -- designs computer chips that are used extensively in modern life. From data centers to smartphones to virtual reality glasses, the world is powered by semiconductors.
Building advanced semiconductors takes a lot of innovation, and making them progressively smaller and more powerful requires intricate and advanced machines. This is where Applied Materials steps in. Without getting into the nitty-gritty details, the company produces the equipment and software that semiconductor manufacturers use to package, etch, and form their chips. Its technology allows fabricators to produce chips with higher performance, lower electricity consumption, and a smaller surface area -- attributes prized in the semiconductor industry.
Given how important these factors are in building chips, Applied Materials is able to charge a lot for its machines and the service contracts that come with them. Over the last four reported quarters, it has generated $27 billion in revenue from customers around the globe.
NASDAQ: AMAT
Key Data Points
Free cash flow growth, falling shares outstanding
Applied Materials' financial performance has been phenomenal over the long term. Its free cash flow over the last four quarters was $7.5 billion, and it has been cash-flow positive over every 12-month period in the 21st century. Even though Applied Materials operates in a cyclical industry, it has been able to consistently generate positive cash flow due to how important its machines are to manufacturers.
With all the cash coming into the business, the company has been able to repurchase a lot of stock. Since 2003, it has reduced its outstanding share count by more than 50%, which helped it grow its earnings per share (EPS) and free cash flow per share. For investors, these are two of the most important metrics to track as they are what create shareholder value over the long term. Free cash flow per share is up by almost 800% over the last 10 years.
ACHR Operating Income (TTM) data by YCharts.
Why you should buy the dip on Applied Materials stock
Investors have sold off Applied Materials stock due to its sharply declining China revenue in its latest fiscal quarter. During its fiscal Q4, which ended Oct. 27, its China revenue fell to $2.1 billion compared to $3 billion in the same period a year ago. Semiconductor manufacturers in China are ordering a lot of machines due to threatened or existing export restrictions from the United States. Investors see those trade restrictions as a major headwind for a segment that accounted for 30% of Applied Materials revenue last quarter.
While this is a concern in the short term, the world will need more computer chips regardless of where they are manufactured. If the tools to make them are less available to companies operating in China, then their production will happen in other nations. But Applied Materials will still find demand for its highly sought-after machines.
After the recent sell-off, Applied Materials is now trading more than 33% below its all-time high. Its stock trades at a trailing price-to-earnings ratio (P/E) of 20 and a forward P/E of 17.7, based on analyst estimates -- well below the S&P 500 index's average P/E of 30. For a company that should grow along with the booming semiconductor market, these earnings ratios seem far too cheap. So buy up some shares of Applied Materials stock on this dip, and hold onto them for the long haul.
