Why Applied Materials, Chip Sector Are Worth a Closer Look

| About: Applied Materials, (AMAT)
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Based on our most recent Nasdaq 100 Watch List, the following question was asked regarding Applied Materials (NASDAQ:AMAT): "Do you like AMAT? They just raised their dividend and seem close to an average low." Based on this question, we took a closer look at the chip related companies on our watch list and noticed that all of the companies started aggressive dividend increasing policies starting around 2002. This alone is a compelling reason to investigate these companies.

In our cursory review of data on Applied Material from Morningstar.com, we found that Applied Material is selling below the average Price-to-Book ratio over the last 10 years by 14%. Over the same period of time, AMAT is selling 22% below the price-to-sales ratio. Finally, AMAT is selling 44% below the price-to-cash flow ratio.

All of these factors indicated that the stock should return to the mean at some point in the future. A glaring negative is the fact that there hasn't been the earnings to justify the stock price and dividend. Dow Theory also indicates that from the peak of $22 to the low of $7.80, AMAT is fairly valued at $14.90. So far the decline in the price from the $15 dollar level has confirmed the Dow Theory view.

However, the last time that AMAT had negative earnings was in 2003. The low in 2003 at $11.50 took the stock to the high of $25 in the same year. Additionally, AMAT didn't fall below $15 until the market decline in 2008, which seems natural given the state of the economy during that period of time (it might not be over yet.) This means that in any given year from 2003 to 2008, AMAT would have returned as much as 46% if based on the average low price of $15 and the average high price of $22.

An important point to consider about the technical pattern of AMAT is the double bottom that was achieved in late 2002 to early 2003. If AMAT were to replicate the same rally on a relative basis then AMAT could rise as high as $18.43, an increase of 43% from the current level. Already, investors are being compensated for 2% of the downside risk through the dividend if the stock were held for a year. As long as investors are willing to stomach the potential of going to the old low of $7.80 in November 2008 then there may be opportunity for this stock.

Our opinion is that the chip sector is ripe for mergers and acquisitions. In terms of AMAT, there are few downside risks if you're willing to accept the volatility and the losses that go along with such an investment. The aggressive dividend policy may pay off in the case of AMAT. However, for the time being, we would review the other chip-related companies with a dividend that has earnings before diving into AMAT. This was just a cursory review of the numbers on AMAT, please verify all data that seems relevant and necessary.

Disclosure: No positions