Applied Materials stock has had a solid year thus far, rising by over 31% year-to-date. In comparison, Applied’s semiconductor industry peer Texas Instruments stock has gained about 14% over the same period. While the company had a mixed 2023, as the broader semiconductor capital spending remained weak as demand for personal computers, laptops, and smartphones eased following the lifting of Covid-19 lockdowns, there are indicators that the semiconductor cycle is turning, driven in part by generative AI tools.

AMAT stock has seen pretty strong gains of 145% from levels of $85 in early January 2021 to around $210 now, vs. an increase of about 40% for the S&P 500 over this roughly 3-year period. In comparison, Arista Networks, another company that benefits from generative AI, has seen its stock surge by over 300% over the same period. Arista is a market leader in high-speed networks focused on hyper-scalers and big corporations. Turns out, Arista is part of the 30-stock Trefis High Quality Portfolio, which has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics.

Coming back to Applied Materials, the company posted a better-than-expected set of Q2 FY’24 results last month, with revenue coming in roughly flat versus last year at $6.65 billion, and adjusted earnings standing at $2.09 per share. The semiconductor downcycle has bottomed out, with memory prices picking up amid slower supply growth, while PC sales are poised to improve marginally this year after declining by nearly double-digit levels in 2023. Separately, the industry is benefiting from a surge in demand from the artificial intelligence space. AI workloads are computationally intensive, calling for a higher amount of computing power and memory.

Applied stands to gain from higher demand, given that it is well diversified across the semiconductor production value chain, offering tools and services ranging from materials engineering, to process control and integration. With cloud service providers planning ambitious capital spending plans centered on improving AI computational capabilities, demand for high-end fabrication equipment is only expected to rise. For instance, per some reports, Microsoft and OpenAI intend to build a new AI data center estimated to cost over $100 billion and begin running in 2028.

Besides this, China is increasingly focusing on developing its own semiconductors as it makes technological self-sufficiency a priority. However, Chinese chip makers have still been very dependent on Applied (and other U.S. companies) products and services to produce their latest chips. For example, Huawei Technologies and its partner Semiconductor Manufacturing International Corp relied on tech including tools from Applied to make the latest 7-nanometer chip for the flagship Mate 60 Pro smartphone.

Applied Materials stock currently trades at about $222 per share. This translates into a valuation of about 27x projected FY’24 earnings. The multiple is slightly high versus historical levels. While trends such as generative AI and cloud computing could drive AMAT’s stock, the company is likely to face some pressure and the company’s exposure to China could prove a double-edged sword, given that the U.S. has been tightening restrictions on the export of semiconductor technology to China. During Q2 FY’24, Applied’s sales to China came in at close to $2.83 billion, accounting for about 43% of total revenue, up 21% year-over-year. We value Applied Materials stock at $202 per share, which is slightly below the current market price. See our analysis of Applied Materials Valuation for a closer look at what is driving our price estimate for the stock.

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