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Despite continued uncertainty in end market demand for semiconductors, the Street is still bullish overall about Lam Research (NASDAQ:LRCX) and Applied Materials (NASDAQ:AMAT). Free cash flow yields may be strong for both firms, but capital intensity and supply chain disruptions weigh on the downside. Based on my review of the fundamentals and multiples analysis, I find significant risks to contrast the otherwise reward story.

From a multiples perspective, Lam Research and Applied appear to have limited room for expansion. The former trades at a respective 12.6x and 11.3x past and forward earnings, while the latter trades at a respective 9x and 11.5x past and forward earnings. To put this into perspective, consider that Lam Research and Applied Materials are valued at 100% and 86% of their 3 Digit MG Group PE multiple. With the volatility in global markets not likely to dissipate until gains in other tech firms are realized, investors should contemplate holding out for now - deferring long positions to when the macroeconomy picks up.

It should be stressed, however, that at the first quarter earnings call, Applied's management noted excellent performance and provided a strong outlook:

I'm pleased to report that Applied started 2012 with a strong first quarter, posting revenue and earnings that exceeded the high-end of our ranges. Global demand for mobile electronics is driving strong capital investments by semiconductor customers, resulting in solid order momentum and higher expectations for our second quarter. The rate of technical change continues to accelerate in all of our markets and leading-edge technology investment remains a priority for our customers…

Let me now turn to the economic outlook. Since the start of the year, we have seen improvements in a number of macroeconomic indicators. While the ongoing recession and increased austerity in parts of Europe remain a concern, we believe the global economic environment will support healthy spending by consumers and businesses.

First quarter earnings per share of $0.18 crushed consensus by 50% off of excellent new order growth of 50%. The addition of the ion implant is further benefitting SSG order momentum and management has guided towards $2.3B to $2.4B - above expectations - for this segment. At the same time, foundry strength drove WFE gains. As the mix shifts towards PVD, CM, and CVD, management is well positioned to control capital expenditures as cost synergies are unlocked form the Varian integration. On the other hand, EES and Display markets fundamentally lack visibility and make up a frightening one-seventh of business. Solar overcapacity, in particular, is a concerning limitation to revenues.

Consensus estimates for Applied's EPS forecast that it will decline by 40.8% to $0.77 in 2012 and then grow by 45.5% and 13.4% in the following two years. Assuming a multiple of 11x and a conservative 2013 EPS of $1.08, the rough intrinsic value of the stock is $11.88, implying 8.5% downside.

At Lam Research, business experienced a 32% drop in memory shipments and are indicating signs of limited sustainability. The company is further exposed to the most price-sensitive areas of the semiconductor market and is under pressure from stronger competitors. With that said, second quarter revenues were solid, though not incredible, at $584M.

Consensus estimates for Lam Research's EPS forecast that it will decline by 63.2% to $2.15 in 2012 and then grow by 72.6% and 22.6% in the following two years. Assuming a multiple of 11x and a conservative 2013 EPS of $3.67, the rough intrinsic value of the stock is $40.37, implying 3.8% downside.

Source: 'Buys' For Lam Research And Applied Materials, Both Haunted By Downside