Micron Technology (MU 3.21%) has been one of the best artificial intelligence (AI) stocks to own over the past few months. If you bought shares six months ago, your position is already up about 250%. That's a monster return in a short time frame, although some contend the stock is still cheap.
Is this the case? Or is there something else going on with Micron's stock?
Micron's stock looks cheap, but there's a catch
If you value Micron's stock on a forward earnings basis, the stock looks incredibly cheap.
MU PE Ratio (Forward) data by YCharts
The stock rallied from nearly 3 times forward earnings all the way up to 12. However, with the S&P 500 trading for about 21.9 times forward earnings, this price tag still looks cheap. So, what's the catch?
It all has to do with the industry that Micron is involved in. Micron makes memory chips, which don't have much differentiating technology. That means that memory chips are fairly commoditized, and there's not a lot of difference between the products Micron offers versus its competitors.
Memory demand goes in cycles, and currently, we're ramping up. AI demand has consumed nearly all memory chip capacity for the foreseeable future, which has caused memory prices to skyrocket.
Image source: Getty Images.
Micron's input costs are relatively stable, so when the price of the commodity soars due to a fixed cost, Micron's profits will also skyrocket. This makes the stock look cheap, at least for the time being.
Once Micron and its peers have expanded their production capacity enough to meet demand, prices for memory chips will drop, and so will Micron's profits. Furthermore, if demand falls, Micron's profits will shrink even more due to having excess production capacity. This highlights the cyclical nature of Micron's business and is the reason why the stock doesn't have a much higher valuation.
But that doesn't mean you have to ignore Micron's stock. While I'm not investing in it, you can still buy shares of Micron today if you believe the memory chip crunch will last for multiple years. The longer the supply is constrained, the longer Micron's profits will stay elevated. If they stay elevated for multiple years, then their stock price could continue to skyrocket.
NASDAQ: MU
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However, this isn't a set-it-and-forget-it investment; investors must keep an eye on this one, as the cycle can turn quickly, which will cause Micron's share price to plummet.
