Applied Materials, Inc.

Let me start where I always start: can I explain how this company makes money to a ten-year-old? Here is the whole thing. Everybody knows the companies that design chips — Nvidia, Apple, Intel. Rather fewer know the companies that make them — Taiwan Semiconductor, Samsung. Almost nobody knows the company that makes the machines that the chip-makers use. That is Applied Materials. It sells the equipment that lays films of material a few atoms thick onto a silicon wafer, carves patterns into them, shoots ions into them to make them conduct, and then inspects the result for flaws too small to see. A modern chip is built up in something like a thousand of these steps. Applied has a machine for most of them.

This makes it something I have always liked the shape of: a toll booth. It does not have to guess which chip designer wins. Whether the world's transistors end up inside a Nvidia accelerator, a Samsung memory stack or a car's engine controller, they were almost certainly built on a line that contains Applied's tools. Founded in 1967 in Santa Clara, California, it grew into the largest supplier of semiconductor manufacturing equipment in the world — ⚠️ a title it has quietly lost. On calendar-2025 revenue ASML earned about $37 billion against Applied's $28.2 billion, and on 2026 guidance ASML will be roughly 1.4 to 1.5 times Applied's size. Applied is now the second-largest, and it has been since about 2023. Almost every profile of this company, including several we read while preparing this one, still says otherwise. In the fiscal year ended October 2025 it booked $28.4 billion of revenue and $7.0 billion of profit. And two days before this letter, on 13 August 2026, it reported the best quarter in its fifty-nine-year history.

"The single most important decision in evaluating a business is pricing power." — the test I apply here, and the one this company passed in public two days ago

On the call for those results, the chief financial officer said something that would have made me sit forward in my chair: "Three years ago, we implemented a systematic approach to value-based pricing, and today you can see the benefits reflected in our strong revenue growth and gross margins, which have increased to over 50% for the company and over 55% in semiconductor systems." Read that plainly. A company that supplies capital equipment to five or six of the most sophisticated, most powerful buyers on earth decided to charge more for the value it delivers — and its customers paid. That is not a slide in a deck. That is the moat showing up in the gross margin line, which is exactly where a moat is supposed to show up.

Note the date, and note the price. At $507.18 the shares have risen roughly 167% in twelve months, from a 52-week low near $154. They also fell about 31% from a late-June high near $740, and then fell another 5.1% on the day after those record results. The business and the share price are telling two very different stories, and this report is mostly about the space between them.

"Never invest in a business you cannot understand." Now, I want to draw a distinction here that matters more for this company than for almost any other on our shelf, because it is the distinction people get wrong. Understanding what a business does and being able to say where it will stand in ten years are two entirely different exercises. Applied Materials is easy on the first and genuinely hard on the second. Here is the chain, end to end:

I want to be candid about the boundary of my own circle, because this is where a reader is most likely to be led astray by a confident tone. I can read this company's accounts and tell you it is a fine business. I cannot tell you what its customers will spend in 2029, and neither can its customers, and neither can the analysts who have raised their price targets by more than $190 in the last year while the business itself did roughly what it said it would do. The demand for these machines is the capital budget of about a dozen corporations. Capital budgets are the most volatile line in commerce. That is not a criticism of Applied — it is the weather this business has always lived in.

Read Applied as one machine business with a service annuity bolted underneath it. The machines are cyclical and magnificent; the annuity is dull and grows every year. FY2025, with the most recent quarter beside it:

Pause on the second of those numbers for a moment, because it is the tell. In December 2025, SEMI forecast 2026 wafer-fab-equipment spending at $126.1 billion. Six months later it forecast $143.9 billion — an upgrade of fourteen per cent to a single year's number, in half a year, on no new physics. The industry's own equipment makers did the same: Applied lifted its calendar-2026 systems growth guidance from "over 20%" in February to "over 30%" in May to "stronger than that" this month. That is what a boom looks like from the inside, and it is exactly the sort of upward-revision spiral that precedes every capital-goods hangover in history. It may run for years. It has never run forever.

Two observations an owner should hold onto. First, the pond is growing and consolidating at the same time — five companies supply most of the world's chip-making equipment, and the technical difficulty of each new generation makes it harder, not easier, for a sixth to appear. Second, and less comfortable: the pond has tides. Applied's revenue went from $16.7bn in FY2018 down to $14.6bn in FY2019 — a 13% fall in a single year, with no recession and no scandal, simply because a dozen customers decided to spend less. In fairness, that fall followed two exceptional years — +36% in FY2017 and +14% in FY2018 — and you may prefer to call it a give-back rather than a decline. Call it what you like; the size of it was set in a dozen customer budget meetings, not by anything Applied did. Anyone reading today's +25% quarter as a run rate should write that number on the inside of their spectacles.

Now to the question that matters more than any other, and I want to answer it precisely rather than with an adjective. My verdict: the moat is real and it is wide, but it is a moat of breadth, not of monopoly — and that distinction sets both its strength and its ceiling. Let me show my work.

Start with what it is not. Applied does not own a single irreplaceable machine. ASML does — nobody else on earth can make an extreme-ultraviolet lithography system, which is why ASML is not really a competitor at all but a neighbour selling a different, unattainable thing. Applied's position is the opposite shape. In etch it meets Lam Research, which holds more than half that market. In deposition it meets Lam and Tokyo Electron. In inspection and measurement it meets KLA, which dominates process control the way ASML dominates lithography. Step by step, Applied is challenged nearly everywhere. A moat scored on any single product line would come in at six.

Everything above is argument. Here is arithmetic. Take the calendar-2025 revenue growth of the five big equipment makers straight from their own filings, and set it against a wafer-fab-equipment market that grew about 12%. No market-research estimates, no paywalled share tables — just what each company reported.

Applied's Semiconductor Systems share of the equipment market fell from roughly 19.1% to 17.8% in a single year — about 130 basis points. That is not a forecast or an estimate. It is what the filings say.

And the obvious defence does not hold. The natural explanation is China: export controls cut Applied out of a market that was 45% of its revenue at the 2024 peak and is now about 30%. That is real, and management has quantified it — roughly a $600 million revenue impact in the current year. But Lam Research has 34% of its revenue in China — a higher exposure than Applied — and it grew 26.8%. Applied itself has said its share in the Chinese segments where it is still allowed to compete was flat year on year. So the China hit is about access, not competitiveness — and once you remove it, a genuine competitive gap remains. Lam's advantage came from etch, from deposition wins, and above all from memory, where the NAND cycle now running is an upgrade cycle rather than a capacity cycle — and upgrades favour Lam's tools over Applied's.

⚠️ One qualifier, stated plainly: fiscal years differ across these companies and currency moves flatter ASML and penalise Tokyo Electron, so treat the magnitudes as approximate. The direction is not approximate. And there is a fair rebuttal: Applied has guided its semiconductor systems business to grow "more than 30%" this calendar year against a market forecast at 23%, which would be a return to outgrowth. We would simply note that it is a guide, not a result, and that the same company promised a doubling of gate-all-around revenue in the year it lost the share.

So where does the width actually come from? Four springs, and they compound on one another.

1 · Breadth is itself the product. Applied is present in more distinct process steps than anyone. That lets it sell something no single-step rival can assemble: an integrated solution across several consecutive steps, tuned as one system. When the difficult part of chip-making stops being "make each step better" and becomes "make these five steps work together," breadth converts from a merchandising convenience into a technical advantage. Trend: widening, because the industry is squarely in that phase.

2 · Switching costs that are measured in yield, not in dollars. This is the strongest spring and the least visible. A chip recipe is qualified tool by tool over years. Once a machine is in a production flow that works, swapping it for a competitor's risks the only thing a fab genuinely cannot afford — yield. So the incumbent keeps the step for the life of the node, and usually gets the first look at the next one. Trend: stable, and structurally durable.

3 · The installed base, which quietly became an annuity. Applied Global Services is now running at $1.8 billion a quarter, growing 22%, at a 30% operating margin, with 37,000 chambers in the field connected to Applied's own software. This is the part of the business a cyclical downturn cannot easily take away — a fab that has stopped buying new tools still has to keep the old ones running. The clearest evidence of its durability is buried in the backlog: at the end of FY2025 the service backlog ($7.14bn) was larger than the entire Semiconductor Systems backlog ($7.11bn). Trend: widening, and it is the single most under-appreciated line in the company.

⚠️ But one adjustment must be made to that growth rate, and we have not seen it made anywhere else. Effective the first quarter of fiscal 2026, Applied moved its 200-millimetre equipment business out of the service segment and into Semiconductor Systems. That business was lower-margin and China-exposed, and it was explicitly blamed in the FY2025 accounts for dragging service margins down. It was removed from the segment in precisely the quarter that service growth accelerated past 20% and margins jumped above 30%. ⚠️ We could not establish whether prior periods were restated. Some unknown part of this inflection is a definitional change rather than an operating improvement, and until the comparatives are clear the 22% growth rate should be treated as flattered.

4 · Research at a scale only four companies can fund. Close to $25 billion of R&D over nine years, 12.6% of FY2025 sales, plus an industry-scale research facility in Silicon Valley — the EPIC Center — where customers and now universities co-develop the next generation. You cannot enter this industry with money. You enter it with twenty years of accumulated process knowledge, or not at all.

And the proof, which arrived on 13 August: gross margin above 50% for the company and above 55% in Semiconductor Systems, with the CFO attributing the gain openly to a deliberate programme of charging for value. A supplier without a moat announces price rises to its customers and loses the business. Applied announced them, and the customers paid, and the margin went up 150 basis points year on year. That is the moat, audited.

And the counterweight, which is where the growth is. The physics is currently moving Applied's way, and it can be measured. As transistors move to gate-all-around structures with power delivered from the back of the wafer, management puts the combined transistor-and-wiring opportunity at $14 billion per 100,000 wafer starts, up from $12 billion — roughly 30% more Applied content for the same number of wafers — and expects to take more than half of it. The high-bandwidth memory used in AI accelerators needs three to four times the wafer starts of ordinary memory for the same output; Applied's business there went from about $1bn to $1.5bn in FY2025 with a stated ambition to double it. Advanced packaging is guided to grow more than 70% this calendar year. None of that requires the industry to build more fabs. It only requires chips to get harder to make, which they reliably do.

Where it could crack — and why I score this 7 rather than 8 or 9. Four places, and the first is the one that moved my score. The share arithmetic above is not a risk; it is a result. Applied grew 2.1% in a year the market grew about 12%, and three of its four peers gained ground. A moat is a device for holding share, and over 2024 and 2025 this one did not hold it. I have marked it down for that, and I would mark it back up if the guided outgrowth in the current year proves durable rather than cyclical. Second, no step is safe individually, and one has already been lost. Applied's share of process control has fallen from a peak near 13% to under 8% while KLA took roughly 63% — a fifteen-year erosion in a segment whose importance is rising. That is not a hypothetical; it is a completed demonstration that this moat can be breached step by step. Third, a large part of the customer base is a political variable — Applied's moat protects it from competitors, not from a rule written in Washington, and in FY2025 two customers alone were about 19% and 15% of revenue, some 34% between them, up from about 23% the year before. (Applied stopped naming them in the FY2025 annual report.) Fourth, and most important to keep straight: a moat protects share and price. It does not protect volume. Applied can hold every step it owns, keep raising prices, and still see revenue fall 13% because a dozen customers cut their capital budgets — which is precisely what happened in FY2019, after growth of +36% and +14% in the two years before it. Call that a give-back if you prefer the gentler word. The direction was still decided by the buyers. Coca-Cola's moat keeps people drinking through a recession. Applied's does not.

I want managers who are honest, able, and who think like owners. The way to test the third one is not to read the letter; it is to watch what they do with the cash when the stock is cheap and again when it is dear.

Weigh those last two cells against each other, because together they say more than any strategy slide. On the company's money, management showed real discipline — buying back heavily in the cheap years (nearly $6.1bn in FY2022) and pulling back sharply to $440m a quarter now that the shares cost 43× earnings. I score that highly; most managements do exactly the reverse. On their own money, the executives were sellers all summer at $590 to $736. Neither fact is scandalous — the sales were spread over months and Mr Dickerson retains a fortune in the stock — but an honest reader should notice that the people who know this business best were converting paper into cash while the market was paying up, and that the treasurer stopped buying at almost exactly the same moment. I score management 8: an excellent allocation record, and a summer of selling that I decline to explain away.

That is a thoroughbred's scorecard, and I do not want to bury the compliment: 40% on equity, half-a-dollar of gross profit on every dollar of sales, more cash than debt, and a company that could pay off every borrowing it has out of one year's operating cash flow. There is no financial risk here worth the name.

But look at the two amber rows near the bottom, because they contain the one thing a casual reader will miss. Applied's free cash flow is running well below its reported earnings — $7.87 a share against $11.60 — and the reason is the +245-day cash conversion cycle. Inventory sits for 154 days; customers take 91 days to pay. To grow revenue 25% you must first fill warehouses and extend credit, and that money leaves before the profit arrives. Now, contrast this with Amazon, whose cycle is minus 51 days — its customers finance the machine. Applied finances its customers. That is not a defect; it is simply what a capital-equipment business is, and the working capital comes flooding back at the top of a cycle when growth stops. But it means that in a boom, the reported earnings are the flattering number and the cash is the honest one — which is the exact opposite of Microsoft, where heavy growth capex made cash flow understate the truth.

We have run this exercise four times now — Microsoft, Alphabet, Amazon — and every time the lesson was the same: free cash flow understated the truth because growth capex was being charged as though it were upkeep. Applied stands the lesson on its head. Here the cash number is lower than the earnings number, and it deserves to be, because the gap is working capital lent to customers in order to grow. Nothing is being hidden and nothing is being distorted — but a reader who arrives expecting the usual "the P/E overstates the price" conclusion should notice that at Applied, the P/E understates it. Forty-three times earnings is the kindest way to describe this valuation, not the harshest.

Here is the trap that has emptied more pockets than any other in this industry, and it is worth stating without decoration: a cyclical business is most dangerous when it looks cheapest, and most expensive when its earnings are at their best. Applied's earnings are, right now, at the best they have ever been — record revenue, record margins, a quarter guided up 51%. Consensus takes that and extrapolates: $12.29 of earnings this fiscal year, $17.05 next, $21.95 by FY2028 — which is to say revenue rising from $28bn to $52bn in three years. At $507, the shares cost 41× this year, 30× next, and 23× the year after that.

Two honest things can be said about those numbers. The first is that they may well be right: the AI infrastructure build is real, it is contracted, and management says leading-edge logic, DRAM and advanced packaging will supply about 80% of industry growth in 2026 and 2027 — which happens to be exactly where Applied is strongest. The second is that you are being asked to pay 43× for today and to accept the 2028 estimate as the reason it is reasonable. If FY2028 arrives as forecast, today's price is fair-to-good. If the cycle does what cycles do — and this company's revenue fell 13% in FY2019 with no crisis at all — then the market will be applying a much lower multiple to a much lower number, and both halves of that sentence hurt at once. There is no version of this price that contains a margin of safety. That is not a prediction. It is arithmetic.