Three AI Chip Plays That Are Cheaper Than ASML And Nvidia

Three AI Chip Plays That Are Cheaper Than ASML And Nvidia
Paul Allison, CFA

8 months ago4 mins

  • Semiconductor manufacturing equipment (SME) companies supply machinery for chipmakers, and while their stock valuations aren’t yet nosebleed-high, they could well benefit from the AI theme.

  • ASML’s the most famous and cutting-edge SME firm, but with a bloated valuation, investors might as well just check out AI superstar Nvidia.

  • The semiconductor downcycle poses a short-term risk to SME companies’ sales and profit, but that might be a valuation opportunity in the long term.

Semiconductor manufacturing equipment (SME) companies supply machinery for chipmakers, and while their stock valuations aren’t yet nosebleed-high, they could well benefit from the AI theme.

ASML’s the most famous and cutting-edge SME firm, but with a bloated valuation, investors might as well just check out AI superstar Nvidia.

The semiconductor downcycle poses a short-term risk to SME companies’ sales and profit, but that might be a valuation opportunity in the long term.

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Semiconductors are facilitating world-changing technology, and that’s no easy feat. Some even say that producing leading-edge chips – the most advanced ones on the market – is the closest thing to magic on Earth. The cost of making them sure is awe-inspiring, anyway: super-advanced chips are often said to be at the “bleeding edge” since they’re so expensive to produce. In fact, chipmakers like Intel, TSMC, and Samsung buy highly complex machines that cost millions of dollars to make.

If you’re keen on artificial intelligence plays, you’ve probably heard of one of these “semiconductor manufacturing equipment (SME) makers”: ASML. It’s the biggest with a market value of $287 billion, and arguably the most famous. ASML’s uber-advanced machines – the size of a double-decker bus and worth up to an eye-watering $160 million – churn out the most advanced AI-powering chips, designed by the likes of Nvidia. Oh, and it has a virtual monopoly to boot.

But ASML’s mammoth sway comes with a valuation to match. And at that price, AI investors may as well check out darling (and expensive) Nvidia. You might, then, be interested in three other SME firms instead. They might not be as glitzy as ASML, and they aren’t as directly exposed to the fancier AI production lines. But with the AI theme expected to pull up demand for all types of semiconductors over the long term, these three SME companies could be worth your while – and your dime.

1. Applied Materials (AMAT)

AMAT is the biggest of the three firms, boasting a market value of $122 billion. This company offers the broadest array of machines, designed to suit the multiple stages of manufacturing for a whole bunch of chip types. Now, that does mean AMAT isn’t an AI pure play, so its stock valuation isn’t as rich as ASML’s.

Price to earnings (P/E) ratio for ASML, Lam Research, KLA, and Applied Materials using forward 12-month earnings forecasts. Source: Koyfin.
Price to earnings (P/E) ratio for ASML, Lam Research, KLA, and Applied Materials using forward 12-month earnings forecasts. Source: Koyfin.

Just check out this chart: AMAT’s 23x price-to-earnings (P/E) ratio (purple line in the chart) makes the firm’s valuation substantially lower than ASML’s, and the cheapest of our four SME firms.

2. Lam Research (LRCX)

Lam’s $88 billion market value makes it the second-biggest of the trio. Like AMAT, its machines are used in the chipmaking process, but Lam’s are a tad more specialized. They’re focused on etching and deposition, two critical production stages, meaning Lam should be in the right spot to ride a semiconductor wave.

On the face of it, Lam’s valuation looks pricier at 27x P/E (yellow line). That, though, is partly because analysts expect the firm’s profit to post the biggest drop of the trio next year. (See, Lam sells kit to firms that produce chips more likely to feel the effects of weaker economic climates, like memory chips.) But because investors are still optimistic about the firm’s future, the “P” for price hasn’t fallen to match the “E” for those potentially lower earnings. The result: a higher P/E ratio.

3. KLA (KLAC)

KLA’s products are a bit different: chipmakers don’t use them in the actual manufacturing process. Instead, they use them like giant quality control machines. By spotting and diagnosing various problems – and importantly, by offering solutions too – during the manufacturing process, chipmakers can cut time and money from this very costly stage. And since KLA’s kit is used in the more advanced production processes, it could be seen as a purer play on AI. That might explain why its shares are a tad more expensive than AMAT’s 25x P/E (orange line).

What are the risks?

First, the elephant in the room: AI could be a flash in the pan. But even besides that, SME companies are highly volatile. Their sales and profit swing wildly, in tune with the rocky semiconductor and general economic cycles. That’s the “bullwhip” effect: the further away you are from the end product – that’s our phones, laptops, cars, and so on – the bigger the potential swings in sales. So if the economy takes a turn for the worse, say, SME firms’ profit could end up stuck in a slump.

The Bullwhip effect: Source: Sketchplanations.
The Bullwhip effect: Source: Sketchplanations.

The semiconductor industry’s actually in a downturn right now, with only a few areas like AI and auto chips bucking the trend. Just take a look at Intel’s share price in the chart if you don’t believe me. On top of that, any worse-than-expected demand for stuff like PCs or cell phones could bullwhip down the supply chain, and hit SME companies’ sales and profit even harder.

Thing is, those short-term risks are precisely what’s kept a lid on the three SME firms’ stock valuations. And actually, downturns can be the best time to consider investing in cyclical businesses. As night follows day, economic weaknesses often give way to renewed, plump profit. So if you can stay focused on the long term instead of the short, and you don’t want to cough up for the likes of Nvidia, then KLA, AMAT, or LRCX might just be the way to go.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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