3 reasons why Lam Research is a must for long-term investors

While the “Magnificent Seven” stocks often get the lion’s share of attention in the tech world, semiconductor stocks outside of it do Nvidia are often ignored by many investors. And semiconductor capital goods (“Semicap”) stocks – the makers of high-tech machines that produce semiconductors – are ignored even more.

And this despite the fact that the semicaps have some of the best companies around. Today semicap leader Lam research (LRCX 3.23%) For long-term investors, it looks like an excellent buy, especially after the sharp decline from its summer highs.

1. A technology leader with an impressive moat

Lam is one of only a few companies producing advanced etching and deposition equipment for chip manufacturing. Deposition devices deposit materials onto a silicon wafer and etching devices remove that material. Given that chips are now literally made from hundreds of billions of transistors on a single semiconductor, and transistors just five nanometers wide are arranged just a few nanometers apart, the process of precisely placing and removing semiconductor material has become incredibly complex.

Lam particularly specializes in etching and deposition processes that stack chip components vertically. The verticalization of NAND flash memory began ten years ago when companies began stacking NAND cells, but today advanced logic and DRAM chips are also operating vertically.

This niche puts Lam in a very good position in the age of artificial intelligence. Advanced logic chips are moving to gate-all-round transistors, where the gate surrounds a transistor on all four sides, allowing transistors to be stacked vertically. Additionally, more and more chips are now using “chiplet” architectures, in which subcomponents are fused into a chip using advanced packaging. And high-bandwidth DRAM memory (HBM) has recently emerged as an important part of AI processing, which also stacks high-end DRAM cells vertically.

These trends directly benefit Lam’s strengths and deepen his technological lead.

2. Lam is an ATM

Growth is nice, but if a company doesn’t efficiently convert that growth into profits, shareholders ultimately don’t benefit.

Fortunately, Lam has huge profits. The company posted an operating margin of 30.3% last quarter, which is fairly typical of Lam’s history and quite high for a hardware company.

In addition, Lam does not need to invest a lot of capital in semiconductor factories like its customers do, as its competitive advantage relies mainly on advanced research and development. Lam’s high margins and relatively low capital requirements allow Lam to achieve a very high return on equity (ROE) of almost 50%. This is a very high ROE compared to the average 15% S&P 500 and even the higher-than-average 25% of the tech sector.

Companies with high ROE generate a lot of cash that can be deployed into new growth opportunities or returned to shareholders in the form of stock buybacks and dividends. To this end, Lam has a policy of returning 75% to 100% of its free cash flow to shareholders over the long term. While Lam has primarily relied on buybacks as its preferred means of returning capital, reducing its share count by about 12% over the past five years, the company has also steadily increased its dividend, with a recent 15% increase in September the current yield of 1.25%.

Lam is also able to return all that cash while maintaining a pristine balance sheet: $6.1 billion in cash and just under $5 billion in debt.

3. After the pullback, it will trade at a value price

Some may debate how cheap Lam Research is at 23x earnings. But these declining profits represent, in some ways, a bottom-line profit reading as many end markets outside of AI have only just gotten over the post-Covid hangover. Additionally, the stock is down 35% from its all-time high last July. As you can see below, that is an even larger decline than the Covid downturn, surpassed only by the declines in late 2018 and early 2022 when the Federal Reserve raised interest rates.

LRCX percent off all-time high, data from YCharts.

But with strong demand for artificial intelligence, many semiconductor end markets just getting over their post-pandemic hangover, and the fact that the Federal Reserve is actually cutting interest rates, it’s a strange time for Lam to see such a big drop to experience.

Therefore, now seems to be a good time to buy stocks for the long term.