The company is undervalued on a DCF basis and has a predictable business
Summary
- The semiconductor supplier faces pressure from trade disputes, but has strong operations.
Driven by the hype surrounding artificial intelligence and strong performances among Magnificent Seven stocks, the tech sector of the S&P 500 climbed 56.40% in 2023. Similarly, the tech-heavy Nasdaq Composite gained around 44%.
As a result, investors may be interested in finding potential opportunities among undervalued tech stocks that have predictable performances heading into the new year.
The Undervalued Predictable Screener, a Premium GuruFocus feature, determines whether a stock is undervalued or overvalued based on two methods: discounted cash flow and discounted earnings.
According to both methods, companies with a discount higher than zero are considered undervalued, while discounts below zero are considered overvalued.
The companies' predictability rates are then determined based on their historical performance over the past decade. The screener looks for companies with ranks of at least four out of five stars.
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Based on these criteria, a number of tech stocks qualified for the screener as of Jan. 22. Among them was Applied Materials
Business structure, opportunities and risks
Founded in 1967, the Santa Clara, California-based company supplies equipment, services and software for manufacturing a variety of semiconductor chips, flat panel displays, solar photovoltaic cells, electronics and energy efficient glass.
Its business is divided in four segments, the largest of which, Semiconductor Systems, generated nearly 75% of the company's revenue in fiscal 2023.
Applied Materials appears to have a strong presence in the space as its counts Intel
Further, it announced earlier this month it is collaborating with Alphabet
However, semiconductor trade tensions between the U.S. and China did put some pressure on the stock last year, so investors should be aware that risk could impact its performance going forward.
Valuation
With a market cap of $140.27 billion, Applied Materials' shares were trading around $168.79 on Monday with a price-earnings ratio of 20.81, a price-book ratio of 8.60 and a price-sales ratio of 5.37.
Having posted a return of nearly 60% in 2023, the stock is currently trading at a 40% discount to its DCF value of $281 and 32% below the discounted earnings value of $247.
The GF Value Line, however, suggests the stock is modestly overvalued based on its historical ratios, past financial performance and analysts' future earnings projections.
It is also trading close to a 10-year high currently.
Regardless of valuation, the GF Score of 94 out of 100 indicates Applied Materials has high outperformance potential, driven by solid ratings for profitability, growth, financial strength and momentum. The value rank is low, however.
Earnings review and outlook
In November, Applied Materials released its fourth-quarter and full-year 2023 results.
For the three months ended Oct. 29, the company posted earnings of $2.38 per share on $6.72 billion in revenue. Net income came in at $2 billion and Ebitda was $2.36 billion. While the company's revenue growth has slowed over the past year and sales were flat compared to the prior-year quarter, net income increased 26%.
Revenue for the full year inched up 3% to $26.52 billion, while net income grew 5% to $6.86 billion, or earnings of $8.11 per share.
In a statement, President and CEO Gary Dickerson commented on the company's strong performance.
“Applied Materials delivered record revenue, earnings and cash flow in fiscal 2023 and is outgrowing the wafer fabrication equipment market for the fifth year in a row,” he said. “Applied's broad product portfolio, strong customer relationships and leadership at major technology inflections put us in a great position to profitably grow the company as powerful trends fuel the semiconductor industry's expansion in the years ahead.”
Looking ahead to the first quarter of 2024, the company anticipates net sales of $6.47 billion and earnings per share in the range of $1.72 to $2.08. The first-quarter report is expected to be released in February.
Financial health
On its balance sheet for the year, Applied Materials recorded $6.87 billion in cash, cash equivalents and marketable securities and $5.99 billion in debt.
While the cash-to-debt ratio of 1.15 indicates the company is able to pay off its debt using cash on hand, the interest coverage ratio is also high at 24.61. Further, Applied Materials is supported by a robust Altman Z-Score of 10, indicating it is in good standing, and a Piotroski F-Score of 8 out of 9, meanings its operations are healthy.
Further, the return on invested capital of 33% eclipses the weighted average cost of capital of 13.43%, implying the company is effectively using its profits to create value.
The company also has a four-star predictability rank. According to GuruFocus research, companies with this rank return an average of 9.80% annually over a 10-year period.
Dividend overview
In December, Applied Materials' board of directors approved a quarterly dividend of 32 cents per share, which will be distributed on March 14 to those on record as of Feb. 22.
While the payment is in line with previous distributions, it is not very appealing compared to other tech companies. The stock yields 0.73% with a payout ratio of 0.14. Further, GuruFocus notes its yield is near a two-year low.
Last year, Applied Materials distributed $3.16 billion to shareholders through a combination of dividend and stock buybacks.
Guru and insider trades
While the stock may not be particularly appealing for dividend investors, 13F filings for the third quarter show value investors seem to like it. Of the 20 Premium gurus invested in Applied Materials as of Sept. 30, Al Gore (Trades, Portfolio)'s Generation Investment has the largest stake with 1% of its outstanding shares. Chris Davis (Trades, Portfolio), Ken Fisher (Trades, Portfolio), PRIMECAP Management (Trades, Portfolio), Philippe Laffont (Trades, Portfolio) and the T Rowe Price Equity Income Fund (Trades, Portfolio) also have sizeable holdings.
Investors should be aware 13F filings do not give a complete picture of a firm's holdings as the reports only include its positions in U.S. stocks and American depository receipts, but they can still provide valuable information. Further, the reports only reflect trades and holdings as of the most-recent portfolio filing date, which may or may not be held by the reporting firm today or even when this article was published.
Despite its popularity, however, the stock did see a number of gurus reduce their positions during the quarter. The stock still has a combined weight of 20.60% in their equity portfolios, though.
Further, there has been a more bearish sentiment toward the stock over the past two quarters with heavy selling activity.
As for insiders, there were a fair number of sell transactions throughout 2023. There has not been a buy transaction since June of 2022.
This heavy selling activity may not be a bad sign, however, since the stock saw a consistently strong performance during the year. As such, they may have simply cashed in on the rise.
Final thoughts
While international trade disputes may impact the stock in the short term, Applied Materials has a strong, predictable business that is effectively creating value as it grows.
Although DCF metrics indicate the stock is trading at a discount, other metrics suggest the price may be a bit elevated currently. As such, investors may want to wait for a slight pullback before entering a position. Either way, though, the stock is likely to create value for them over the long term.
Disclosures
I/we have no positions in any stocks mentioned, and have no plans to buy any new positions in the stocks mentioned within the next 72 hours.
As an expert in finance and technology, I can confidently analyze the key concepts presented in the article about the undervalued tech stock, Applied Materials Inc. (AMAT). My expertise in financial analysis, particularly in discounted cash flow (DCF) and discounted earnings, allows me to provide insights into the valuation, business structure, opportunities, risks, earnings review, outlook, financial health, dividend overview, and guru and insider trades related to Applied Materials.
Valuation:
The article highlights that Applied Materials is undervalued on a DCF basis, with a price-earnings ratio of 20.81, a price-book ratio of 8.60, and a price-sales ratio of 5.37. The company's market cap is $140.27 billion, and its shares were trading at $168.79, representing a discount to its DCF value of $281 and discounted earnings value of $247. The GF Value Line suggests the stock is modestly overvalued based on historical ratios, past financial performance, and analysts' future earnings projections. Despite the valuation concerns, the GF Score of 94 out of 100 indicates high outperformance potential.
Business Structure, Opportunities, and Risks:
Applied Materials, founded in 1967, operates in Santa Clara, California, and is a semiconductor supplier. The company provides equipment, services, and software for manufacturing semiconductor chips, flat panel displays, solar cells, electronics, and energy-efficient glass. Its largest segment, Semiconductor Systems, generated nearly 75% of the company's revenue in fiscal 2023. The article mentions collaborations with Intel, Taiwan Semiconductor Manufacturing Co., Alphabet's Google, and a lithography partnership with Ushio for AI systems. However, it also notes potential risks due to semiconductor trade tensions between the U.S. and China.
Earnings Review and Outlook:
Applied Materials posted strong results for the fourth quarter and full year of 2023, with record revenue, earnings, and cash flow. Despite slowed revenue growth over the past year, net income increased by 26%. The CEO, Gary Dickerson, expressed confidence in the company's position for profitable growth in the semiconductor industry. The outlook for the first quarter of 2024 anticipates net sales of $6.47 billion and earnings per share in the range of $1.72 to $2.08.
Financial Health:
The balance sheet reveals $6.87 billion in cash and marketable securities, with $5.99 billion in debt. The cash-to-debt ratio is 1.15, indicating the company's ability to pay off its debt using cash on hand. Key financial health indicators, such as the interest coverage ratio, Altman Z-Score of 10, and Piotroski F-Score of 8 out of 9, suggest that Applied Materials is in good standing and has healthy operations.
Dividend Overview:
Applied Materials' board approved a quarterly dividend of 32 cents per share in December. While the dividend is in line with previous distributions, it yields 0.73%, with a payout ratio of 0.14. The article notes that the yield is near a two-year low, and the stock may not be particularly appealing for dividend investors.
Guru and Insider Trades:
The article discusses 13F filings, revealing that value investors, including Al Gore's Generation Investment, Chris Davis, Ken Fisher, PRIMECAP Management, and the T Rowe Price Equity Income Fund, have sizable holdings in Applied Materials. However, it mentions a more bearish sentiment among gurus in the past two quarters, with some reducing their positions. Insiders have been involved in selling transactions throughout 2023.
Final Thoughts:
In conclusion, despite potential short-term impacts from international trade disputes, Applied Materials is recognized for its strong and predictable business, effectively creating value. The article suggests that, based on DCF metrics, the stock is undervalued, but other metrics indicate a possible current overvaluation. Investors are advised to consider waiting for a slight pullback before entering a position, with the expectation that the stock is likely to create value over the long term.
