Assuming that you had $100,000 to invest a decade ago and decided to split that money equally between shares of ASML Holding (NASDAQ:ASML) and Applied Materials (NASDAQ:AMAT), you would have easily been a millionaire by now thanks to their massive gains.
Shares of these semiconductor stocks have crushed the broader market over the past 10 years, with ASML alone turning a $50,000 investment in 2011 into $945,000 now. Applied Materials has also been a terrific buy, as $50,000 invested in the stock a decade ago would now be worth $610,000.
ASML data by YCharts
However, investors who have missed the terrific rally of these stocks need not be disappointed, as they could replicate their outstanding performance over the next decade. Let's see why that may be the case.
ASML Holding is the leader in a lucrative market
ASML provides photolithography machines to semiconductor manufacturers, and not surprisingly its offerings have been in great demand thanks to the global chip shortage. The company's second-quarter revenue jumped 21% year over year to 4 billion euros ($4.8 billion). Its diluted net income increased from 1.79 euros per share in the year-ago period to 2.52 euros ($3.00) last quarter.
ASML's gross margin of 50.9% for the quarter exceeded its guidance on the back of higher software-related revenue, which was driven by customers' need to quickly increase manufacturing capacity. The bright end-market prospects encouraged ASML to increase its full-year guidance. The company now anticipates 35% revenue growth in 2021, up from its earlier estimate of 30% growth.
Image source: Getty Images.
It wouldn't be surprising to see ASML maintain this impressive rate of growth for a long time, as it is the dominant player in the market for the lithography machines that are used for fabricating chips. According to a third-party estimate, ASML commands a 62% share of the market for lithography machines, while holding a monopoly position in the extreme ultraviolet (EUV) machine space, which is growing at an astronomical pace.
According to a third-party report, the global EUV lithography market is anticipated to hit $13.3 billion in revenue by 2024, a big jump over the $2.16 billion in revenue it generated in 2018. The market's compound annual growth rate (CAGR) of 35% over the forecast period bodes well for ASML, as it is the only manufacturer of EUV machines in the world. Meanwhile, the overall photolithography equipment market is expected to hit $18 billion in revenue by 2026.
ASML generated nearly 14 billion euros in revenue in 2020, of which 4.5 billion euros ($5.3 billion at the current exchange rate) came from the sale of EUV systems. So ASML's EUV revenue could more than double in the next three years considering the impressive pace of the broader market's growth.
Meanwhile, the company's installed base management business, which produced 27% of its total revenue in the second quarter, has also been firing on all cylinders. The segment's revenue exceeded guidance last quarter as customers upgraded their equipment at a faster pace to increase productivity in a bid to meet the end-market demand. ASML management pointed out on the Q2 investor call that "customers are looking to upgrade to provide the fastest path to increase their wafer output capability."
ASML now expects its installed base management business to record 15% revenue growth this year, up from its earlier expectation for 10% growth. As ASML sells more of its photolithography systems to chipmakers, the installed base business should also get better and clock robust growth in the long run.
All of this makes it clear why analysts are anticipating ASML to clock nearly 30% annual earnings growth for the next five years. The company could grow at an impressive pace beyond the forecast period as well, as global semiconductor revenue is expected to hit $1 trillion by 2030, compared to $400 billion last year, according to a third-party estimate. As such, ASML is a solid long-term bet to take advantage of the world's growing appetite for semiconductors, which could help it remain a top growth stock for an exceptionally long time.
There's no stopping Applied Materials
Applied Materials has been on a fine run over the past year and a half. Demand for its semiconductor fabrication equipment has jumped big time to alleviate the global shortage of chips.
AMAT data by YCharts
The company delivered record revenue and earnings last quarter. Revenue jumped 41% year over year to $6.2 billion, while earnings shot up 79% to $1.90 per share. Applied Materials also recorded a 3 percentage point increase in its adjusted gross margin last quarter to 48%.
The company pointed out in its quarterly earnings presentation that multi-year growth drivers are "firmly in place" for the semiconductor industry. For instance, the semiconductor content in high-end smartphones is expected to increase from $170 last year to $275 by 2025. Data center servers are expected to use $5,600 in semiconductor content by 2025, which would be double what they were consuming last year.
Not surprisingly, semiconductor manufacturing equipment sales are growing at an outstanding pace. Industry association SEMI estimates that annual spending on semiconductor equipment could exceed $100 billion next year, a big jump over 2020's spending of $71.1 billion. More importantly, the elevated spending on semiconductor equipment is likely to continue, as chip sales are forecasted to keep rising through the end of the decade.
The company estimates that its semiconductor systems revenue could jump to $31 billion by fiscal 2024 from $17.2 billion in fiscal 2021 in a best-case scenario, translating into a CAGR of nearly 16%. That's significantly faster than the annual revenue growth that the company has clocked over the past decade.
The good part is that Applied Materials' growth isn't just restricted to sales of semiconductor equipment. The services and display businesses together produced nearly a third of its total revenue in fiscal 2020.
The services business is the bigger one of the two, with 24% of total revenue last fiscal year, and it has been clocking impressive growth as the demand for recurring services, parts, and software has increased. The company's services revenue was up 24% year over year last quarter to a record $1.29 billion.
Applied Materials points out that 87% of its services revenue was recurring in Q3 2021. The segment seems well-placed to sustain its impressive growth, as Applied Materials has an installed base of 40,000 systems in the services business. The company should be able to expand this base significantly, as there are more than 160,000 of its systems deployed across the globe.
Additionally, Applied Materials is enjoying a subscription renewal rate of 90%. The company also points out that customers are now signing longer service agreements. This is evident from its average contract length of 2.2 years in the previous quarter, compared to 1.9 years at the end of 2020. What's more, 77% of its customers are signing multi-year agreements.
In all, Applied Materials seems well placed to keep up its impressive growth in the future. Analysts expect the company's earnings to grow at a CAGR of close to 27% for the next five years. However, it wouldn't be surprising to see it do better than that on account of the growing subscription business. As such, investors who have missed Applied Materials' rally so far have solid reasons to buy this tech stock, as it seems built for more upside.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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