How Applied Materials Stock Can Surge To $350

Could Applied Materials stock (NASDAQ:AMAT) reach $350 in the next few years? We think there is a real possibility. Consider this, less than two years ago, at the end of October 2022, Applied Materials stock was trading at around $80 levels. Since then, the stock has grown to a little over $200 per share. Looking at the valuations, Applied stock trades at 25x trailing earnings and just about 21x projected 2025 earnings. This is a very reasonable valuation when considering the company’s steadily expanding earnings and strong position in the semiconductor manufacturing equipment space. We use Applied Materials revenues, profitability, and valuation multiples in the scenario below to demonstrate a potential path to a roughly $350 stock price over the next few years.

AI’s Growing Demands Will Drive Revenue Growth

Applied Materials revenues have risen at a healthy pace, growing at an annual rate of 16% over the last few years and the momentum can hold up. While Applied is likely to see sales growth cool to about 2% this year to about $27 billion, consensus projects a close to 12% growth for FY’25. However, if Applied grows its sales at an average annual rate of close to 22% for the next three years, led by higher demand from more sophisticated tools for producing memory and logic chips for AI, its revenues could move from around $27 billion in FY’24 to around $49 billion by FY’27 or a roughly 81% increase. There are a couple of trends that could help accelerate revenue growth in the coming years.

Separately, last month’s monetary easing by the Federal Reserve could provide a boost to Applied. The Fed cut interest rates by 50 basis points in September, marking the first rate cut in close to four years.  With the current benchmark federal funds rate standing at 4.75% to 5% post the cut, there also remains room for the central bank to lower interest rates further.  Also, check out our analysis of other ways to profit from the Fed’s next move?  As a major supplier of highly specialized semiconductor fabrication equipment, Applied Materials is dependent on the capital spending cycle of major chipmakers such as TSMC and Samsung. Now lower interest rates effectively reduce borrowing costs for manufacturers and make larger projects more viable. This, in turn, could drive up demand for the high-end equipment that Applied – the largest U.S.-based semiconductor equipment maker – supplies. Looking for more companies that can benefit from increased digitization and AI deployment? See our analysis of Internet Infrastructure Stocks.

Applied Has Already Done It In The Past

Applied Materials has fared well in recent years, growing from levels of about $85 in early 2021 to over $200 currently. That said, the increase in AMAT stock over the last 4-year period has been far from consistent, with annual returns being considerably more volatile than the S&P 500. Returns for the stock were 84% in 2021, -38% in 2022, and 68% in 2023. In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, is considerably less volatile. And it 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.

Margins Should Remain Thick Driven By Higher-End Products

Combine this robust revenue growth with the fact that Applied’s adjusted net margins (net income, or profits after all expenses and taxes, calculated as a percent of revenues) are on an improving trajectory – they grew from 19.6% in FY’19 to 25.6% in FY’23 as the company witnessed better economies of scale and a more premium product mix. We believe that margins could trend still higher to levels of about 31% by FY’27, as Applied focuses on new technologies such as Gate-All-Around (GAA) semiconductor equipment, while better managing its costs. Applied is also seeing its services sales grow at a faster pace compared to products and this could also help margins, as services contracts provide largely recurring revenues and are increasingly focused on more lucrative software. Applied has also been quite disciplined with its capital spending versus other players in the chip space, and this could also help its margins trend higher. Now combining the roughly 80% revenue growth with about 20% increase in margins translates into a roughly 2.1x growth in earnings over the next three years.

Strong Results Mean A Smaller Contraction In Earnings Multiples

Now, if earnings grow 2.1x, the PE multiple will shrink by 2.1x to levels of about 12.5x, assuming the stock price stays the same. But that’s exactly what Applied Materials’ investors are betting will not happen. If earnings expand 2.1x over the next few years, instead of the PE shrinking from a figure around 25x now to about 12.5x, a scenario where the PE metric stays at about 20x looks quite likely, as the stronger growth and expanding margins give investors more confidence about Applied Materials’ future. This would make the growth of AMAT stock to levels of about $350 within the next few years a real possibility. What about the time horizon for this high-return scenario? While our above example illustrates a roughly three year time frame, in practice, it won’t make much difference whether it takes three years or four, as long as Applied is on this revenue expansion trajectory, with margins holding up, the stock price could respond similarly. 

[1] Returns as of 10/14/2024
[2] Cumulative total returns since the end of 2016

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