Applied Materials (NASDAQ:AMAT) has a Great Return, Is it Time to Sell High?

Long-term investing can be life changing when you buy and hold the truly great businesses. Quality companies can see their share prices grow by huge amounts. In the case of Applied Materials, Inc. (NASDAQ:AMAT), the share price is 374% higher than it was five years ago. This just goes to show the value creation that some businesses can achieve.

Sometimes we have a great, fundamentally backed company, which is riding a market wave and providing its investors with amazing returns. When we examine a bit more closely, we can see that there are developments that are propping up this stock - and related companies.

The problem we encounter when having a high market wave is twofold.

• First, is the possible accommodation of the current semiconductor shortage by the industry, which will drive down margins of producers.
• Second, is the fact that the future cash flows of the company are already included in the current price.

This means that Applied Materials, will have to deliver over and above the current earnings surprises for an extended period of time in order for the stock to have upside potential.

We can see that the market is handsomely pricing-in the future shortage of products that Applied Materials can deliver in the following chart: 

We are now going to examine the past performance, and see how the company has transformed returns for shareholders.

See our latest analysis for Applied Materials

While markets are a powerful pricing mechanism, share prices reflect investor sentiment, not just underlying business performance.

One imperfect but simple way to consider how the market perception of a company has shifted is to compare the change in the earnings per share (EPS) with the share price movement.

During five years of share price growth, Applied Materials achieved compound earnings per share (EPS) growth of 36% per year. This EPS growth is remarkably close to the 37% average annual increase in the share price.

This indicates that investor sentiment towards the company has not changed a great deal. Indeed, it would appear the share price is reacting to the EPS.

The image below shows how EPS has tracked over time (if you click on the image you can see greater detail).

We can see that there is at least one potential quarter of high growth before earnings stabilize. This can provide investors with an additional window of upside. The period after that however is less clear, and if the earnings stabilize, them sentiment may switch from bullish to neutral, which can push investors to cycle away from the stock.

We know that Applied Materials has improved its bottom line lately, but is it going to grow revenue? This free report showing analyst revenue forecasts should help you figure out if the EPS growth can be sustained.

What About Dividends?

As well as measuring the share price return, investors should also consider the total shareholder return (TSR). The TSR is a return calculation that accounts for the value of cash dividends (assuming that any dividend received was reinvested) and the calculated value of any discounted capital raising and spin-offs.

Arguably, the TSR gives a more comprehensive picture of the return generated by a stock.

In the case of Applied Materials, it has a TSR of 406% for the last 5 years. That exceeds its share price return that we previously mentioned. This is largely a result of its dividend payments!

The current dividend yield stands at 0.71%, which is a off from the historical average of around 2.2%. This means that investors may not get the future benefits of Applied Materials if they are coming from a dividend perspective.

A Different Perspective

Applied Materials shareholders have received a total shareholder return of 125% over the last year. And that does include the dividend. That's better than the annualized return of 38% over half a decade, reflecting that the company is doing better recently.

The future window of earnings growth can soon close, and the stock can be on the way to stabilization. There may be a good case to be made to take some profits and re-invest them into companies with higher potential growth. Investors can also decide what is the target price which they wish to see before becoming satisfied with the performance.

To understand Applied Materials better, we need to consider many other factors. Even so, be aware that Applied Materials is showing 2 warning signs in our investment analysis , you should know about...

Of course Applied Materials may not be the best stock to buy. So you may wish to see this free collection of growth stocks.

Please note, the market returns quoted in this article reflect the market weighted average returns of stocks that currently trade on US exchanges.

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Simply Wall St analyst Goran Damchevski and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.