When looking for large-cap companies with strong fundamentals and reasonable prices, I have taken to using a simple screener that looks for companies that have a market cap of at least $10 billion, a GF Score of more than 90 out of 100 and a PEG ratio of less than 1.00.
This is a variation of Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio)’s principle that “It’s far better to buy a wonderful company at a fair price, than a fair company at a wonderful price.” The GF Score is a unique assessment tool from GuruFocus that measures key fundamentals. According to backtestings from GuruFocus, stocks with higher GF Scores tend to outperform those with lower GF Scores over the long run.
One stock I recently discovered using this screener is Applied Materials Inc. (AMAT, Financial). First, this company has a market cap of $106.72 billion, which means it is a large-cap. Second, it has a high GF Score of 98 out of 100, driven by high ranks for financial strength, profitability, growth, momentum and GF Value:
About the company
On its website, the company describes itself this way: “We are the leader in materials engineering solutions used to produce virtually every new chip and advanced display in the world.”
Applied is a leading expert in creating production tools for the semiconductor industry. In its 10-K for 2022, it noted, “With its diverse technology capabilities, Applied delivers products and services that improve device performance, power, yield and cost. Applied’s customers include manufacturers of semiconductor chips, liquid crystal and organic light-emitting diode (OLED) displays, and other electronic devices.”
Interestingly, Applied moved roughly in lockstep with the broader semiconductor industry until 2020. At that point, the industry dropped off dramatically and hasn’t recovered. On the other hand, Applied’s revenue just kept growing. This divergence may be due in part to the de-globalization of the semiconductor industry.
Since the Covid-19 pandemic, it has significantly outperformed the industry. Will it keep growing like this?
GF Score breakdown
Looking at the components of the GF Score to assess the company's fundamentals, thanks to a modest amount of debt, it receives a financial strength rating of 8 out of 10. It has an interest coverage ratio of 24.92, which means it generates $24.92 in operating income for every dollar of interest expense it pays. That’s backed up by a high Altman Z-Score of 8.78, which is well above the safe zone that begins at 3.00.
Profitability scores a full 10 out of 10. It has an operating margin of 29.64% and a net margin of 24.57%. Both are industry-leading for the semiconductors industry. What’s more, it has a return on equity of 52.74% and has been profitable in each of the last 10 years.
Growth also receives a 10 out of 10 ranking. Over the past three years, revenue growth has averaged 23.90% per year, Ebitda has averaged 32.10% and earnings per share without non-recurring items has averaged 37.50%.
Free cash flow, which provides funding for further expansion, has also grown by an average of 21.00% per year over the past three years.
Valuation is the fourth major category among fundamentals. It has a price-earnings ratio of 16.75, which is somewhat better than the industry median of 21.09.
Combine that with a five-year Ebitda growth rate of 18.30%, and we have a PEG ratio of 0.92. That’s near the top end of the undervalued range.
The GF Value chart considers Applied to be fairly valued.
Discounted cash flow
The discounted cash flow calculator considers Applied to be significantly undervalued when I plug in a 10-year earnings per share growth rate projection of 20.00%, which I think is conservative considering earnings per share growth over the past 10 years averaged 47.60%. For the discount rate, I used 10%.
Shareholder returns
Applied pays a smallish dividend, currently yielding 0.82%. It also repurchased shares at an average rate of 2.70% per year over the past three years.
Gurus
Applied enjoys extensive confidence among the gurus followed by GuruFocus. At the end of the first quarter of 2023, 22 of the gurus had stakes in the company. 13F filings tell us Al Gore (Trades, Portfolio) of Generation Investment Management had the largest position, with 7,487,386 shares. This represented 0.89% of Applied’s shares outstanding and 4.90% of the firm's 13F holdings.
The second and third largest positions belonged to Chris Davis (Trades, Portfolio) of Davis Selected Advisors (7,143,519 shares) and Ken Fisher (Trades, Portfolio) of Fisher Asset Management (4,137,738 shares).
Roughly two-thirds of its shares, 65.78%, have been bought by institutional investors, and 2.08% belong to insiders. The biggest position among insiders is that of Gary Dickerson, a director, president and CEO, who owned 1,808,245 shares as of last Dec. 19.
Investors should be aware that 13F filings do not give a complete picture of a firm’s holdings as the reports only include its positions in U.S. stocks and American depository receipts, but they can still provide valuable information. Further, the reports only reflect trades and holdings as of the most-recent portfolio filing date, which may or may not be held by the reporting firm today or even when this article was published.
