When a stock gains 90% in a single year, as Applied Materials has in 2019, we may worry that the party may be ending soon. Things are set to improve even more though.
Applied Materials has been one of the very best stocks out there in 2019, putting in a very impressive 90% gain for the year. When you are in the top 3 gainers in the entire market, this will have people worried that they may be overbought, but in the case of this stock, things may just be getting started, and it may still have quite a bit of gas left in the tank after this storied run.
The semiconductor industry is red hot, and the entire stock market has been led by AMD who are up 153% in 2019, far and away the stock of the year. The semiconductor sector in general has also easily outdistanced all rivals, and the most impressive thing about this is that they have done this during a downturn in the industry that we’re just starting to come out of now.
We need to realize that the market is forward looking, and will always use the data available to it and take it into consideration now, not then. The downturn in the second half of 2018 was due to the expected downturn in 2019 in other words, and the huge rally in 2019 is based upon things set to improve in 2020 and beyond.
Applied Materials saw their earnings drop by 23% year over year during their last earnings call, but this was expected and they actually beat analysts’ estimates by a bit with this, as they have done consistently lately. Starting with the $3.04 per share they earned over the fiscal year ending in October, earnings are expected to rise to $3.77 in fiscal 2020, $4.32 in 2021, and to $5.28 in 2022. This is some nice earnings growth indeed.
We need to keep in mind though that all this is known and is expected, and is therefore already priced into the stock’s price as they say, and if we are looking to grow the stock based upon earnings, we will require better numbers to do it. To the degree that we fall short of these targets, this would be expected to cause the stock price to decrease even though we may see a healthy year-over-year earnings growth increase.
It certainly doesn’t hurt to see this sort of increased growth in earnings though, and while we can rightfully say that these things aren’t news, and we need to be careful in looking at good projections like this and assuming that this in itself is bullish for a stock over the time period looked at, this still can cause stock prices to rise, for the same reasons as stocks usually exceed earnings growth generally, by way of momentum.
This is indeed a bullish trend, but the bullishness comes from looking beyond this timeframe and use it to establish ideas of where the company might be in, say, 2030 or 2035. There are a number of things to look at to determine this, and this starts with Applied Materials’ dominant position in their industry, being the leader in machinery and applications to produce various chips.
The company is now better diversified and doesn’t just rely on demand for computers as they used to. They still get about two-thirds of their revenue from the sale of machines that manufacture silicon computer chips, but they are also now make a lot of revenue from software and support related to this, in addition to making memory chips and flat panels from displays. The memory and flat panel business are in the doldrums right now, but if these two components of the business improve, and memory chips are expected to pick up soon, this offers them the opportunity to further bolster the company’s growth and earnings.
We always want to start with a stock’s chart, and seeing the big V pattern would certainly give technical analysts pause for thought, at least while it remains below the resistance level that it is currently stuck at. This is the level that they faltered at back in 2000, and took until last March to make it back, where it stalled. It took another shot at this level in November, but once again wasn’t able to climb this wall, and are about to challenge it once again as they regroup for another try.
Entering right at this resistance area, whether you are a trader or investor, would simply be a terrible idea, and this is one of the things that the fundamental analysts who are recommending this stock don’t mention, probably because charts really aren’t their thing. It needs to be our thing though because this is an integral part of timing both entries and exits, and while we may be looking to hold this for many years and therefore may think that this doesn’t matter much, jumping on a roller coaster on the way down when you instead want to go up isn’t a good idea and this mistake costs everyone the price of admission on the downward leg.
Several Analysts Expect a Good Year for 2020 for This Stock
Cowan analyst Krish Sankar is not bothered with the big move up that Applied Materials has had this year, although this is normally the sort of thing that scares these analysts plenty. If anything, Sankar might want not be more careful, as this move did at least burn a lot of gas out of the company’s tank, even though there may be more left and even quite a bit more perhaps.
When we look forward to the company’s better prospects that we know about, we need to realize that, once again, this is all history. Everything that Sankar and the other analysts that are bullish on this stock mentions as reasons to buy it is already old news, seeing them chase the past. If we had a time machine that we could use to go back to where the semiconductor business was projected to turn around, now we’d have something to work with, and we could just buy and watch the market digest al this good news.
This would be especially profitable with a stock that took such a big hit from the downturn, where they lost half of their stock’s value over the last 9 months of 2018, and given that this company is so solid, this provided them with more room to grow. That show is over though and we’re in re-runs now, even though there are plenty of people who watch them and this still may serve to increase demand for the stock further. In this case though, it will be the stock’s momentum itself that will be carrying the ball, the technicals in other words and not the fundamentals, at least the fundamentals that we have projections for.
That can be more than enough though to at least make this stock a decent play in 2020, whether or not it will perform so well as to deserve to be the stock play of the year as it is for Sankar. If we get over this current level, this opens up the skies and there are no more resistance points out there to slow it down.
It would not be wise though to buy it here and just hope it will make it, even though it does seem to have the momentum to finally get over this hump. The problem with this is that there is always a lot of money at the top looking to take profits after a move like this, which can turn the tide and reverse the momentum, and this is not a stock that you want to be on the wrong side of if this happens.
Aside from the concerns about a potential reversal here, we also need to account for the much higher risk that this stock has, especially after just seeing it almost double in price. This is the sort of thing that will have even the most aggressive momentum traders take a step back, and while even risk like this can be managed, it won’t be if we don’t seek to do so.
What this means is that if we are willing to give this stock a go here, we really need to keep it on a tight leash, and the moment where the move looks like it is failing, it needs to be time to go. Selling when a move fails doesn’t mean that we can’t re-enter when the sun comes out again, but this stock produces a lot more rain than your average stock when the skies open up, and we need to be ready to run for cover if they do.
Fundamental analysts don’t speak of such things though, because this is also outside their scope of vision, but like we don’t want to drive down the road and send text messages at the same time, stocks do require that we pay attention to them as well. This is especially important in the nascent stage, where we are trading or investing based upon a certain idea that needs to be monitored enough to be able to tell if we are right or wrong about this, as well as allowing us to pick the right and not the wrong time to get into the trade.
In order to succeed, we need to be willing to use all the tools at our disposal, and not just focus on a more limited view such as looking at a company’s fundamentals, which at best only tell part of the story. What we need here is people considering the prospects of the stock going higher based upon this information, and then actually go and do it and sustain the price growth we’re hoping for to a satisfactory level. Otherwise, we’re just left to guess way too much, and the less guesswork we need, the better.
If the Momentum and Value Investors Team Up, We Really Could Go Somewhere
One of the things that analysts find appealing is that Applied Materials’ P/E ratio is still below the average of the market even after this 90% surge, by 12% in fact, and this is a pretty big deal to them. This would normally be a negative though, if not for the huge momentum to the upside that we are seeing now, where they may indeed take their rightful place among the outperformers in the market if this can continue for a while.
By comparison, AMD’s P/E ratio is more than 10 times higher than Applied Materials. It is currently at 243, way beyond what it would take to blow any fundamental analysts’ mind. The 95 P/E that this stock started the year at was plenty high enough to blow their minds, yet this hardly served as an impediment to it going up more, both the stock’s price and its price to earnings ratio.
To the extent that this may matter, it only matters to serve to give us an idea of how little investors care about such a thing, and when you run this up to 95, this means that they are looking at something else besides current earnings, and looking at something much bigger. Even if this ends up being an illusion, it is an apparition that can be very effective in driving up the price of a stock. If we are instead looking to shun such phenomena because it doesn’t fit our very limited view of stocks, we don’t really deserve to benefit from these things.
The ticket to the big movers normally requires that we set our fears of high P/E aside, although this is one case where we have the analysts on our side with a big mover, and they do influence people. This is what may set this stock apart right now, as we otherwise could just jump on the semiconductor sector ETF and expect even better returns with less risk than Applied Materials will probably deliver in 2020.
The term “value” is even being used with this one, and this goes directly to the stock’s lower than average P/E. As difficult as it may be to make sense of using value in such a way, it’s all about the perception, and if a stock has this much momentum and you can get the so-called value investors to jump on as well, that can add further to the move.
To get an idea of how much the views of these analysts lag reality, David Wong of Nomura Instinet upgraded this stock from neutral to buy in November, after it moved up this 90%. Neutral is not a word that fits this stock at all, but this does make us wonder what they are looking for when they see a stock almost double and then decide it’s a buy.
Perhaps it took that long for the many ducks that they use to align the right way, but the duck that matters the most is called price performance, which overshadows the rest. Although it often does not make sense to tell people to buy something after it has run up this much, is at resistance, and especially given that it is very much prone to excessive profit taking at the first sign of trouble, at least Wong’s courage right now is admirable.
This does look like it may very well may be a buy here, if it can only show us enough that it is not done, but we need to look both ways before we cross this street. With the penchant for corrections in January, especially in hot stocks in hot sectors, caution is definitely advised if we do decide to take his advice. We could be down a pretty big chunk of change with the prospects of it getting back to where we entered anytime soon disappearing in the rear-view mirror if we are not careful.
We like this stock long-term though, and this is a company who has been around since the dawn of semiconductors and go all the way back to 1967, long before this business even got off of the ground. Chances are, this industry will continue to grow for a long time, and as it does, companies will need to continue to rely on Applied Materials to build all those chips, and therefore the future of this company looks very bright.
We still need to pay close attention to where we get in on this, and it’s still an open question where this may be headed next year. We won’t see anything close to 90%, as this move was for the most part a recovery from the tanking the stock did in 2018, but it still could do very well next year if it shows us that it is up for it. It’s just better to watch and see though right now rather than just guess.
The sector index, the iShares PHLX Semiconductor ETF, may be worthy of an even longer look, which buys the whole industry essentially. While Applied Materials may be as close to buying the index as you can get, this is the real thing, and it is also performing like a champ these days.
It hasn’t moved quite like AMD or Applied Materials, but doubling the Nasdaq is nothing to sneeze at, and without the influence of semiconductors on this index, the gap would have been even larger.
This ETF could even be held long-term, and if you are going to do that, this is a case where it may be better to be diversified rather than putting all of your chips in one basket. It isn’t stopped at a red light either, as the light is green at least for now, although it is especially important in this volatile sector to keep your eyes on the traffic signals and stop if the light clearly turns red.
Over the long haul, those who just want to keep going through these stop lights can be expected to still do very well anyway, although with this industry, you definitely need to heed the barricades, as the cliffs they protect are particularly steep. This really is the fast lane, but if you’re willing to take the wheel, this can be an amazing ride, where you can actually shoot for the numbers that so many look back upon and lament and wish they could go back there, but do not have the courage to jump aboard this train when they are standing right in front of it.
This train isn’t quite ready to board yet, but it looks like it may be leaving the station soon it and it is time to at least grab your suitcase and wait to see if the doors open rather than try to pry them and perhaps be taken to a different town, one where things aren’t so friendly.