Applied Materials (AMAT) stock is currently hovering near its 200-day moving average as investors reacted to the US–China trade tensions and a weak start to the semiconductor earnings season. While the external environment is tense, the company’s fundamentals are strong. As a result, value investors are holding the stock while traders are trading on the volatility.
As value investor Ben Graham wrote in The Intelligent Investor, “Price is not equal to value. Price is what you pay, value is what you get.” Long-term investors rely on the fundamental valuation of a company to determine whether its current stock price fairly values it.
Forward price-to-sales ratio
The forward PS (price-to-sales) ratio is based on analysts’ sales estimates for the next four quarters. This ratio tells us the amount investors are willing to pay per dollar of a company’s sales.
On May 9, AMAT had a forward PS ratio of 3.2x, lower than KLA-Tencor’s (KLAC) ratio of 4.2x but higher than Lam Research’s (LRCX) ratio of 2.9x. LRCX has the lowest ratio of the three because analysts expected the company’s 2018 sales to rise 37.8% YoY (year-over-year). Analysts expect AMAT’s and KLAC’s 2018 sales to rise 21.0% and 15.0%, respectively, on a YoY basis. A low ratio indicates that investors haven’t priced in the growth potential.
Forward price-to-earnings ratio
Because AMAT, LRCX, and KLAC are mature stocks delivering strong earnings and cash flows, a better valuation ratio to consider is the PE (price-to-earnings) ratio. Because investors invest in stocks with future growth potential, the forward PE ratio is an adequate valuation metric.
The forward PE ratio is based on analysts’ EPS (earnings per share) estimates for the next four quarters. This ratio tells us the amount investors are willing to pay per dollar of a company’s EPS.
On May 9, AMAT had a forward PE ratio of 12.0x, which is lower than KLAC’s ratio of 13.7x but higher than LRCX’s ratio of ~11.4x. AMAT’s forward PE is based on analysts’ consensus estimate of 41.0% YoY growth in its 2018 GAAP[1. generally accepted accounting principles] EPS to $4.47. Analysts expect KLAC’s and LRCX’s 2018 EPS to rise 34.0% and 89.5%, respectively, on a YoY basis.
Price-to-cash flow ratio
The PCF (price-to-cash flow) ratio tells us the amount investors are willing to pay per dollar of cash flow earned by a company. Cash flow represents what this company invests in the business and returns to shareholders. This metric is free from the accounting treatment.
On May 9, AMAT had a PCF ratio of 13.1x, lower than KLAC’s and LRCX’s respective ratios of ~12.6x and 12.0x.
What price ratios say about AMAT
These ratios show that investors haven’t priced in AMAT’s and LRCX’s strong growth potential for 2018 over concerns that a potential trade war with China would significantly impact the sales growth of the three companies. AMAT and LRCX are currently undervalued and present a solid buying opportunity for value investors.
In the final article of this series, we’ll look at the efficiencies of these three companies.
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