Lam Research's Long-Term Investment Worthiness Justified by These 3 Factors
While the popular "Magnificent Seven" tech stocks often grab the spotlight, semiconductor stocks beyond industry titan Nvidia often go unnoticed by many investors. This is especially true for semiconductor capital equipment (semicap) stocks, the manufacturers of high-tech machinery essential for semiconductor production.
Currently, semicap leader Lam Research (LRCX 3.80%) stands out as an intriguing buy for long-term investors, particularly following a significant pullback from its summer highs.
1. Unrivaled Expertise in Critical Technologies
Lam is among a select group of companies offering advanced etch and deposition equipment for chip manufacturing. Deposition equipment layers materials onto a silicon wafer, while etch equipment removes unnecessary material. Given today's chips feature billions of transistors on a single semiconductor, with transistor dimensions now down to five nanometers, these precision processes have become remarkably complex.
Lam specializes in etch and deposition processes that create vertical chip structures. Verticalization in NAND flash memory dates back a decade, beginning when companies started layering NAND cells, but today, advanced logic and DRAM chips are also transitioning to this approach. This niche reputation puts Lam in a favorable position in the era of artificial intelligence, where advanced logic chips transform to gate-all-around transistors and sub-components are fused together in chiplet architectures, all relying on advanced packaging techniques.
Furthermore, high-bandwidth DRAM memory has emerged as a key component in AI processing, powered by vertically stacked high-end DRAM cells. These trends further strengthen Lam's technological moat.
2. A Cash Cow
While revenue growth is essential, converting profit from that growth is paramount to shareholder satisfaction. Lam boasts impressive profits, boasting an operating margin of 30.3% last quarter, typical of its long-term track record, and well above the average for hardware companies.
Lam's competitive edge revolves mainly around advanced research and development, with minimal semiconductor fab investments required. This light capital investment load translates into an exceptionally high return on equity (ROE) of nearly 50%, far outpacing the S&P 500's average ROE of 15% and even the technology sector's ROE of 25%.
High ROE companies generate substantial cash reserves, which can be devoted to investment opportunities or shareholder rewards, such as dividends and share repurchases. Lam adheres to a policy of returning 75-100% of free cash flow to shareholders over the long term, with share repurchases resulting in an 12% decrease in shares outstanding during the past five years. The recent dividend increase in September raised the current yield to 1.25%.
Moreover, Lam maintains a balanced and healthy financial position, holding $6.1 billion in cash while carrying $4.9 billion in debt.
3. Undervalued Resources for the Long Term
Despite a trailing price-to-earnings ratio of 23, some may question Lam Research's apparent undervaluation. However, these earnings figures represent a trough in profitability, as many end-market sectors, outside of AI, emerge from their post-pandemic rut.
The stock rallied with an impressive 35% increase from its previous all-time high in July, surpassing even the declines vividly experienced during times of Federal Reserve interest rate escalations.
However, given AI demand's robustness and the rebounding of various end-market sectors, a significant pullback seems puzzling. Consequently, this current situation represents an excellent time to acquire shares for the long term.
Investing in Lam Research (LRCX) could be a smart move for financially savvy individuals seeking long-term growth. With its strong operating margin and impressive return on equity, the company generates substantial cash reserves, which it often returns to shareholders in the form of dividends and share repurchases.
Furthermore, Lam's niche expertise in advanced etch and deposition processes, essential for creating vertical chip structures, provides a significant technological moat, especially in the era of artificial intelligence. This, combined with its light capital investment load, positions Lam as a potentially undervalued stock in the semiconductor industry, making it an attractive option for those looking to diversify their money in finance.
