Tuesday, November 20, 2007

Applied Materials (AMAT) Valuation

Applied Materials, Inc., (AMAT) is a maker of semiconductor fabrication equipment. It has a long history of profitability. This year it is gearing up selling equipment to make solar panels, so it is part of the Green Technology boom. So how should we value its stock?

Unfortunately these are not boom times for silicon equipment manufacturers. Reported results for the fiscal 4th quarter ending October 29, 2007 (See Analyst Conference Summary), included revenues of $2.37 billion that were down 6% from year earlier. It was also a 7.5% slump from the fiscal 3rd quarter.

Net income was roughly down the same, to $422 million.

Still, that shows there is plenty of profit margin built into AMAT's products. Net income was 5.6% of revenues.

Generally, you want to believe that this is just a slow period due to macroeconomic uncertainty. So revenues will go up again. But in this situation you can argue what the P/E (price to earnings) ratio of the stock should be. A wide spectrum is possible.

Today AMAT stock ended at $, giving it a market capitalization of $25.1 billion. Multiply Q4 net income by 4 and you have an annual run rate of $1.69 billion. So the current P/E is 15, and inverting that you get a rate of return on the stock of 6.7%, which is not bad at all. Unless earnings continue to decline; then it would not look so great.

Trailing earnings (the sum of the last 4 reported quarters) are higher than 4 x Q4, so if you want to use that for your annual earnings estimate you get a lower PE and a higher rate of return.

I agree with management that if macroeconomic turmoil increases 2008 could be a rough year. But if people calm down, they will see that demand for electronic devices is booming globally. Many fabs are running at pretty near capacity. So 2008 could also see an increase in equipment orders to keep up with demand and with changing technologies.

When you throw in that Applied Materials has really just gotten started in solar with their SunFab equipment, I think the chances of an improved 2008 are pretty good. The downside risks are relatively low.

That means I believe Applied Materials is undervalued at today's price. On the other hand the stock market is in a funk right now, so you can pick stocks randomly and most will prove to be undervalued.

More data:

Applied Materials Investor Relations page
My Applied Materials (AMAT) page

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