AI stocks still have a lot of room to run.
Despite some concern about a bubble in the artificial intelligence (AI) sector, AI stocks are once again climbing near all-time highs following the Federal Reserve’s decision to lower benchmark interest rates.
One measure of AI stocks, the VanEck Semiconductor ETF, an exchange-traded fund (ETF) that counts Nvidia, Taiwan Semiconductor Manufacturing, and Broadcom as its top three holdings, is up 10% from two weeks ago, though it’s still down 16% from its peak in July.
One AI stock in particular seems oversold, is expecting a rebound in revenue, and has a wide economic moat thanks to its unique product advantages, all of which make it an excellent buy heading into the new year.
I’m talking about ASML (ASML 0.27%), the leading maker of lithography systems, machines that use light to make semiconductors.
Image source: Getty Images.
What is ASML?
ASML is a Dutch company that was founded in 1984 as a joint venture between the electronics company Philips and Advanced Semiconductor Materials International (ASMI), a manufacturer of chipmaking machines.
After several decades of innovation, rolling out new products, and making acquisitions, ASML is the clear leader in lithography systems today. It introduced its first prototype of an extreme ultraviolet (EUV) machine in 2010, which uses a shorter wavelength that allows for smaller chip features that make them faster and more powerful.
The EUV machines have become the state-of-the-art industry standard for semiconductor production, but ASML is still the only company that manufactures them. It does have competitors that make less advanced deep ultraviolet machines (DUV).
That gives ASML a wide economic moat as the EUV machines are very expensive to make and the company has unmatched intellectual property, a long history of research and development, and key supplier and customer relationships in the industry. ASML spent 20 years developing the technology, working with suppliers and partners to do so.
The machines are highly complex, containing around 100,000 parts, and shipping them requires dozens of freight containers and trucks, as well as three cargo planes. In a typical quarter, ASML sells a small number of these very expensive machines. In the second quarter, it sold 100 lithography systems.
Where ASML stands today
Thanks to its dominance of its industry, ASML has built a formidable business, on track for more than $30 billion in revenue this year, and it’s highly profitable with an operating margin that has hovered around 30% in recent years.
However, the company does face challenges. The industry is emerging from a cyclical downturn after revenue jumped in 2023 and management has said that 2024 would be a transition year as it expects strong demand to return in 2025.
Separately, the intensifying tech cold war with China has also impacted the business. In response to U.S. demands, the Dutch government has restricted ASML from exporting its most advanced systems to China, which could impact its revenue.
Why the stock is a buy before 2025
Sluggish growth in recent quarters, concerns about China, and worries about a broader bubble in AI have all weighed on the stock since its peak in July. ASML is down 28% since then.
However, looking ahead to 2025, the future looks much brighter as the company expects strong sales growth next year, noting secular growth in key semiconductor end markets like green energy, electrification, and new applications.
Additionally, the foundry industry is on the verge of a construction boom as a number of chip stocks like TSMC, Samsung, and Intel are planning to open new fabs to accommodate skyrocketing demand for semiconductors in the AI era. That should ensure a bright future for ASML over the next five years as it faces no competition in EUV machines.
While its earnings are currently suppressed because of the cyclical slowdown, the stock trades at a forward P/E of just 24 based on 2025 earnings estimates. Considering ASML’s competitive advantages and future growth opportunities, the stock looks like a steal at that valuation.
Jeremy Bowman has positions in Broadcom. The Motley Fool has positions in and recommends ASML, Nvidia, and Taiwan Semiconductor Manufacturing. The Motley Fool recommends Broadcom and Intel and recommends the following options: short November 2024 $24 calls on Intel. The Motley Fool has a disclosure policy.