Applied Materials: Solar power play

NEW YORK (Money) -- Even if it's not the most timely stock, Applied Materials looks like a compelling value for long-term tech investors. The company also has a great additional appeal.

The leading producer of semiconductor-manufacturing equipment is using its technology to branch into other areas, such as flat-panel displays and solar panels. Both of those markets have tremendous long-term growth potential.

Most alternative-energy products are made by small emerging companies. But the potential market for the type of solar panels made by Applied Materials equipment could expand massively as the cost of manufacturing drops. And that would make Applied Materials one of the few blue-chip investments in a leading sector of alternative energy.

The case for the company's basic business is simple enough. Applied Materials is the dominant producer of certain key types of semiconductor-manufacturing equipment used, in particular, to make memory chips for personal computers.

The business has a high core growth rate - around 15 percent a year - but is highly cyclical. Chip sales themselves fluctuate a lot. And chipmakers only buy expensive new capital equipment when there has been a major technological breakthrough or when they are unable to keep up with chip demand.

When one of those two things happens, all the major chipmakers rush to upgrade at the same time. The result: equipment makers such as Applied Materials can stagnate for three years or longer at a time and then see sales soar all at once.

It makes no sense to invest in shares of a chipmaking-equipment company - whatever other businesses it may have - unless you're willing to get in when business is at a trough and the shares are cheap. Then you have to be willing to wait several years until you catch the next wave of upgrades.

In fact, Applied Materials seems to be at just such a trough. Right now, chipmakers are running at less than 90 percent of capacity, so there is little pressure for an immediate equipment upgrade. And business is likely to continue to be soft through the first half of 2007.

But a number of analysts expect an upturn in chip demand before the end of the year. And a couple of them have upgraded Applied Materials (Charts) stock to a buy within the past month.

The stock's long-term earnings growth is projected at 15 percent a year and the yield is more than 1 percent. Nonetheless, at $18.57 the shares trade at less than 14 times earnings for the fiscal year beginning Oct. 1.

Those numbers are compelling by themselves. But the current excitement about the stock has to do with the company's other businesses.

The technology used to deposit thin films of semiconducting material on chips is not far from the technology needed to make flat-panel displays and solar panels. So it has been a natural move for Applied Materials to diversify into those businesses.

Solar-panel manufacturing equipment currently accounts for less than 3 percent of Applied Materials' revenues. But sales could more than double over the next three years. And as the price of making the panels comes down, the potential growth in demand is enormous.

With a below-market price/earnings ratio and above-average potential earnings gains, Applied Materials looks like a great long-term opportunity as long as you're well enough diversified to ride out any stagnation or big share-price swings.

The company also has virtually no debt. So you're essentially getting a free kicker: One of the few top-quality investments in one of the most promising forms of alternative energy.

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