Better Buy: Universal Display vs. Applied Materials
Though technology is an increasingly important part of everyday life, 2018 was a year worth forgetting for many tech suppliers. As the past year proved, momentum can sometimes be just as important as growth itself, and slowing momentum can wreak havoc on stocks for which investors have high expectations.
That was the case for OLED-screen supplier and patent holder Universal Display (NASDAQ: OLED) and semiconductor industry service company Applied Materials (NASDAQ: AMAT). Universal Display lost 47% of its value on the year, and Applied Materials lost 37%. However, as the New Year gets under way, the two bludgeoned stocks look like a good value.
The rise of OLED
The last couple of years, OLED (organic light-emitting diode) screens have steadily increased in availability, especially in the smartphone market. Prices for OLED TVs also continue to fall as adoption rises and TV manufacturers ramp up their production numbers. That has been a boon for Universal Display, which owns many of the patents and sells many of the raw materials that go into the manufacture of OLED displays.
Despite the tailwinds blowing at the company's back, 2018 was nevertheless a tough year. Growth has dissipated as many OLED makers hit the pause button on new production as they revamped assembly lines to gear up for increased volume in 2019. The result has been a down year for Universal Display -- revenues and operating income through the third quarter of 2018 were down 19% and 53%, respectively -- which sent the stock price hurtling lower.
Management says 2019 should result in "meaningful growth" once again, which could make shares a decent pick right now. Trailing 12-month price to free cash flow (money left over after operations and capital expenditures are paid for) currently sits at 33.8. That's hardly a value, but if Universal Display does flip from sales contraction to growth once again, profitability will grow at an even faster pace. No specifics have been issued as far as what to expect in the new year, but the longer-term trend for OLED as the dominant display technology looks like it's on a firm foundation.
Image source: Getty Images.
Semiconductors set for a rebound?
After several years of growth driven by increasing demand from things like data centers, connected autos, and wearable technology, the semiconductor industry had the brakes tapped on it in 2018. That's bad news for Applied Materials, which provides services, process technology, and material sales to semiconductor makers. Though revenue and operating income for the company's recently finished 2018 fiscal year were up 19% and 24%, respectively, that's a big slowdown from the 34% revenue and 80% operating income increase posted in 2017.
Add to that management's guidance for a 12% year-over-year sales decline in the first quarter, and the slowdown in semiconductors was too much for investors to stomach. Much of the blame has been laid on memory chips, a historically up-and-down sector that accounted for a third of Applied Materials' revenue last year. Expectations are that memory won't bottom out until the second half of 2019. The OLED movement and its potential rebound in upcoming quarters is a potential positive, but not enough of one to expect a quick turnaround for the chip materials supplier.
The good news is that much of the upcoming pain has already been priced in after the stock's tumble. Price to free cash flow currently sits at a mere 10.6, and one-year forward price to earnings is at 7.4 -- implying an eventual turnaround for the bottom line by the end of 2019, at least as far as Wall Street analysts are concerned. That could spell opportunity for investors willing to exercise some patience with this stock.
Two buys for two different reasons
While Applied Materials is the cheaper of the two options here, things could get worse before they get better. If the semiconductor slump continues longer than anticipated or worsens, there could be more downside left for shares. Trying to catch a falling knife like this is best accomplished by purchasing small lots at a time, an approach I am currently taking with semiconductor stocks in general right now.
The same could be true of Universal Display, though, especially with the company's higher valuation than Applied Materials'. However, Universal has fewer moving parts than Applied Materials' diversified business that relies on various segments of the chipmaking industry. OLED tech momentum is building, making Universal a pure play on a fast-expanding segment of the technology manufacturing process.
Thus, while I think both stocks are a great way to bet on the rising importance of technology, Universal Display could be in store for a faster rebound than Applied Materials.
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Nicholas Rossolillo and his clients own shares of Universal Display. The Motley Fool owns shares of and recommends Universal Display. The Motley Fool has a disclosure policy.
