Lam Research Corporation (NASDAQ:LRCX) makes the machines that chipmakers use to build chips. The stock is up about 73% so far this year. It ranks 7th in our list of the 10 best return on equity stocks to buy now.
Why is Lam growing? The reason is simple. Chips are made on thin silicon discs called wafers. Lam’s tools add ultra-thin layers of material to a wafer, remove material that isn’t needed, and carry out other steps that shape the tiny structures inside a chip. The company also sells equipment for advanced packaging, which connects chips together, and it earns money from servicing its machines, selling spare parts, and upgrading them after they are installed.
Amid the booming AI demand and the critical role of the company, LRCX is found in many billionaire portfolios. It’s one of the best AI stocks to buy according to Stanley Druckenmiller.
Bull Case
Lam can grow faster than the chip industry because chips are getting harder to make. Each new generation needs more manufacturing steps on every wafer, so chipmakers need more of Lam’s equipment even when they don’t make many more wafers. Memory chips are stacking more layers, new designs for memory and for the transistors inside processors add steps, and AI chips need advanced packaging, so all of it creates demand for Lam’s tools. Once a chipmaker approves a tool for a production step, it usually keeps using it, because replacing reliable equipment is expensive, and more chipmakers are choosing Lam for their most advanced chip generations. Each machine Lam sells also brings years of service, spare parts, and upgrade revenue, so a large installed base provides recurring income. Sales have grown faster than costs, which means profit has grown faster than sales. If AI keeps raising chip complexity, Lam sells more tools, earns more from servicing them, and keeps more of each sales dollar.
Photo by Yiorgos Ntrahas on Unsplash
Bear Case
The biggest risk is that customers cut back. Chipmakers spend heavily on equipment in good years and pull back in bad ones, so Lam’s sales can fall fast when they delay purchases. A handful of customers account for more than half of its sales, and a large share of revenue comes from China, so export restrictions or a trade fight could cut revenue sharply. More complex chips only help if customers adopt the new designs and pick Lam’s tools over a competitor’s, so delays or lost deals would slow growth. Profit grew strongly last year, but cash from operations fell, and if that continues Lam has less cash to invest, pay dividends, and buy back shares. Profit margins are already high, which leaves less room for further gains. The stock also trades at a high price, so a disappointing report could hit Lam Research Corporation hard.
Wondering how strong Lam’s edge over its rivals really is? See whether its economic moat is widening or narrowing.
Valuation
Lam Research Corporation looks expensive, but its growth explains most of the premium. It trades at a forward P/E of about 37, almost twice the S&P 500’s forward P/E of about 19 and about 46% above its own five-year average of about 25. Over the past year, its revenue grew about 26% and its earnings per share grew about 39%, against about 10% a year for the market over the long run, and analysts expect earnings growth of about 63% in fiscal 2027 and about 24% in fiscal 2028. Adjusted for the growth analysts expect, the stock is only about 10% above the sector median and about 38% below its own five-year average. The price is fair only if growth stays strong, and if it slows below the 24% analysts expect for fiscal 2028, a P/E of 37 looks too high for Lam Research Corporation.
Lam is also on our list of the 10 best AI stocks according to billionaire Stanley Druckenmiller, where it ranks fifth. Click here to see the other nine picks and which stocks rank ahead of it.
While we acknowledge the risk and potential of LRCX as an investment, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns and doing so within a shorter time frame. If you are looking for an AI stock that is more promising than LRCX and that has 10,000% upside potential, check out our report about this cheapest AI stock.
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This article is originally published at Insider Monkey.
