Better Chip Stock: Asml Vs. Applied Materials

ASML (NASDAQ: ASML) and Applied Materials (NASDAQ: AMAT) are two of the world's largest semiconductor equipment makers. ASML is the world's leading producer of lithography systems, which are used to optically etch circuit patterns onto silicon wafers. It's the only supplier of high-end extreme ultraviolet (EUV) lithography systems which are used to manufacture the world's smallest, densest, and most power-efficient chips.

Applied Materials provides a wider range of semiconductor manufacturing equipment, services, and software for the foundry, logic, and memory chip markets. It also sells manufacturing equipment for LCD and OLED screens. Both companies are considered linchpins of the semiconductor sector.

But over the past three years, ASML's stock dipped 5% as Applied Materials' stock rose 15%. Let's see why that happened, and if Applied Materials remains the stronger semiconductor equipment play than ASML.

ASML faces macro and regulatory challenges

ASML, which is based in the Netherlands, monopolizes a key link in the semiconductor market's supply chain with its EUV systems. All of the world's leading foundries -- including Taiwan Semiconductor Manufacturing, Samsung, and Intel -- need to keep purchasing ASML's EUV systems to produce the world's highest-end chips.

These massive systems cost more than $150 million each and require multiple planes to ship. Its next-gen high-NA EUV systems, which are required to produce even smaller chips, currently cost about $380 million. It took ASML decades to develop its EUV technology, so it won't face any meaningful competitors for the foreseeable future.

Yet ASML's growth still ebbs and flows with the cyclical semiconductor market. It's also highly exposed to the tech and trade war between the U.S. and China, which has already barred it from selling its EUV systems and some of its older deep ultraviolet (DUV) lithography systems to Chinese chipmakers. It still generated 26% of its revenue from mainland China in 2023.

ASML's revenue rose 33% in 2021, 14% in 2022, and another 30% in 2023. That growth was driven by robust sales of new PCs during the pandemic (2020-2021), the 5G upgrade cycle in the smartphone market, and the growth of the AI market.

But for 2024, analysts expect its revenue to only rise 2% as it grapples with the tighter export curbs against China and laps the AI market's initial growth spurt. It's gradually shipping its first high-NA EUV systems, but its top customers won't use that cutting-edge technology to mass produce their latest chips yet. Its EPS is expected to dip 4%.

In 2025, analysts expect ASML's revenue and EPS to grow 15% and 27% as the market warms up again. Its stock seems reasonably valued at 28 times next year's earnings and it pays a forward yield of 0.9%, but it isn't a screaming bargain yet.

Applied Materials faces bigger problems in China

Applied Materials' revenue rose 12% in fiscal 2022 (which ended in October 2022), but only grew 3% in fiscal 2023 and 2% in fiscal 2024. Its growth decelerated as the macro headwinds chilled the PC, smartphone, industrial, and automotive markets. The tighter export curbs also throttled its sales to China, which accounted for 37% of its total revenue in fiscal 2024.

Moreover, the U.S. Department of Justice (DOJ) has been scrutinizing Applied Materials' prior equipment sales to China's top chip foundry, SMIC, over the past year. The American company's heavy dependence on China also reportedly caused its application for CHIPS Act funding (for a $4 billion R&D center) to be rejected this July.

However, Applied Materials still expects its growth to accelerate again as the market's demand for more powerful AI chips, new energy-efficient chips, and denser memory chips heats up again. It plans to gradually reduce its exposure to China while locking its customers with new integrated solutions that merge multiple steps (such as material deposition, etching, and material modification) into a single system. It's also expecting a fresh growth cycle for its smaller LCD and OLED businesses.

That's why analysts expect Applied Materials' revenue and adjusted EPS to grow 9% and 10%, respectively, in fiscal 2025. Based on those expectations, its stock looks cheap at 17 times forward earnings and it pays a forward dividend yield of 0.9%.

Which stock is a better buy?

ASML underperformed Applied Materials over the past few years because it was overvalued relative to its growth potential. ASML's bulls believed its dominance of the crucial EUV market justified that premium valuation, but it lost its luster as its growth flatlined in 2024 and it issued a cautious outlook for 2025. That said, its current valuation looks a bit more attractive relative to its long-term growth potential.

Meanwhile, Applied Materials' valuations were compressed by the concerns regarding its future in China. But if you believe it can weather those headwinds and offset that pressure with its growth in other markets, it might be undervalued at its current prices. I wouldn't rush to buy either of these stocks, but I think ASML's monopolization of the EUV market, its lower overall exposure to China, and its stronger growth rates still make it a more promising investment than Applied Materials.

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Leo Sun has positions in ASML. The Motley Fool has positions in and recommends ASML, Applied Materials, Intel, and Taiwan Semiconductor Manufacturing. The Motley Fool recommends the following options: short February 2025 $27 calls on Intel. The Motley Fool has a disclosure policy.