The Obvious
Applied Materials is a cyclical company. How else can one explain a company that lives and dies by the book-to-bill ratio? When demand outstrips supply (a ratio greater than one -- as was the case with the recent 1.34 showing) the world is beautiful. When the orders can't keep up with production capacity, well, the sky in that once beautiful world is suddenly falling.
You get the picture? Let's put it another way. Last week, the Semiconductor Equipment Association of Japan reported that sales of chipmaking equipment rose in January for the seventh consecutive month. What seems swept under the rug was the fact that the sales had run negative for fifteen straight months before that. There's consistency even in this state of erraticism.
So, right now, the semis are smoking. Chips haven't been this hot since either:
- the Keebler elves were pulling out a fresh batch from the oven.
- Erik Estrada and Larry Wilcox were riding for the California Highway Patrol in the 1970s.
- Jalape�o Doritos were pulled off the shelves after triggering a water shortage.
Let me get specific. 1995. Rosy. Through August, shares of Applied Materials had tripled. What a coincidence, today we also find that shares have almost tripled over the past eight months. Then history knelt down on all fours behind Applied as the market pushed it over. A year later Applied was back where it started.
Easy come. Easy go.
The Contradiction
Maybe things will be different this time. It's not just computers anymore. Everyone's buying up cellular phones and the demand for parts has been the only thing holding back the handsets. What about the new generation of smart appliances? Didn't I read where even a milk carton will have a chip to let me know when it's going bad or running low?
Face it, demand isn't going to dry up. Even more impressive is the fact that the chips themselves have gotten better over the years. They keep getting smaller and more efficient. They're using copper now, too.
This is not 1995, when our original Fool Portfolio bought in only to lose some serious coinage and eventually cashed out 31% poorer. Besides, split-adjusted, the original Rule Breaker collection would have done nicely to hold onto its original stake.
At a split-adjust price of $14 3/8 the Fool hadn't bought high after all.
Contradicting Contradictions
The problem with these cyclical stocks, these equities that routinely take three steps forward only to take two steps back, is that any kind of annualized regression relies on the present state of euphoria. Using last week's close of $94 1/4, it represents a 556% increase in just four-and-a-half years. Nice.
But what if an investor sensed that history was going repeat itself. August 1995, like April 2000, felt too cheery. The view from the seesaw's pinnacle was all too clear. Buying in just 11 months later at $5 1/2 would find that investor 1,618% richer today.
Mind-boggling, isn't it? But why go from trough to peak when market lemmings tend to time it the other way around. Let's say we take 1995 and run it through a Xerox. Let's say that Applied is about to shed 64% of its value over the next 11 months again. That would find the stock trading just 128% higher over the course of 5 1/2 years.
To put this in relative terms, August of 1995 was also the month where the Nasdaq Composite crossed the 1000 point mark. As of last week, the Nasdaq was fetching 348% more than it did when the Fool bought Applied. And, for those who have been led to believe that the Fool made a mistake in selling when it did: The Rule Breaker has risen tenfold since August of 1995, or double Applied's still healthy showing.
I can't knock the quality of Applied. There's a reason why Fortune named it one of America's Most Admired Companies. It is clearly the leader in wafer fabrication systems and that means it will continue to play a role for all chipmakers. It took advantage of the Asian flu to acquire companies on the cheap. But when you have the right company in the wrong sector, the tide of the industry will spare no player when it's set on dragging everybody down.
Consider Barrick Gold <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ABX)") else Response.Write("(NYSE: ABX)") end if %>. It has always been the leader in gold production. It is the lowest-cost producer. Amazing economies of scale. Unfortunately, when gold is out of favor it forgives no one. Barrick is trading at half its highs set four years ago. Never dismiss the sector characteristics in company analysis.
While I hate to mention gold and semiconductors in the same breath, the truth of the matter is that they are both commodities and history has proven that the time to buy in is when most speculators are cashing out. The opposite also applies -- to more than just Applied.
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