Why Benjamin Graham Might Have Picked Applied Materials (AMAT)

Farm & Heavy Construction Machinery firm Applied Materials is one of the rare companies that fulfills most of Graham’s requirements for a defensive high-quality stock.

At Market Inference, we adhere to Benjamin Graham’s view that precise forecasting of a company’s prospects is highly uncertain. Investing with a wide margin of safety, determined on the basis of the company’s historical track record, offers far greater chances of positive investment results.

Applied Materials Is Probably Overvalued

Graham devised the below equation to give investors a quick way of determining whether a stock is trading at a fair multiple of its earnings and its assets:

√(22.5 * 4 year average earnings per share (5.19) * 4 year average book value per share (16.825) = $44.33

After an impressive 35.0% performance over the 12 months, Applied Materials is now trading well over its price because its Graham number is 217.3% above today's share price of $140.64. Even though the stock does not trade at an attractive multiple, it might still meet some of the other criteria for quality stocks that Graham listed in Chapter 14 of The Intelligent Investor.

Impressive Revenues, Consistent Profitability, and a Growing Dividend Imply Value

Applied Materials’s average sales revenue over the last 4 years has been $20.16 Billion, so by Graham’s standards the stock has sufficient revenues to make it worthy of investment. When published in 1972, Graham’s threshold was $100 million in average sales, which would be the equivalent of around a half million dollars today.

Ben Graham believed that a margin of safety could be obtained by investing only in companies with consistently positive retained earnings. Retained earnings represent the cumulative net earnings or (deficit) left to equity holders after dividends have been paid out. Applied Materials had positive retained earnings from 2008 to 2022 with an average of $18.36 Billion over this period.

Ben Graham would also require a cumulative growth of Earnings Per Share of at least 30% over the last ten years.To determine Applied Materials's EPS growth over time, we will average out its EPS for 2007, 2008, and 2009, which were $1.20, $0.70, and $0.10 respectively. This gives us an average of $0.67 for the period of 2007 to 2009. Next, we compare this value with the average EPS reported in 2020, 2021, and 2022, which were $1.23, $6.40, and $7.44, for an average of $5.02. Now we see that Applied Materials's EPS growth was 649.25% during this period, which satisfies Ben Graham's requirement.

Applied Materials’s Balance Sheet Meets Graham’s Criteria

It was also essential to Graham that the company’s current assets outweigh its current liabilities, and that its long term debt be inferior to the sum of its net current assets (current assets minus total liabilities). This is the aspect of the analysis that most companies fail, yet Applied Materials passes comfortably, with an average current ratio of 2.2, and average debt to net current asset ratio of 3.9.

Conclusion

Graham is best known for the Graham number valuation method, and his net-net strategy of investing in a broad portfolio of companies that trade below their net current asset value. But these approaches are too narrow, and fail to capture the full scope of Graham’s statistical approach to stock picking.

Applied Materials offers a rare combination of value, growth, and profitability. So it comes as no surprise that the company isn’t cheap enough to meet Graham’s definition of a net-net, and that it does not trade, on average, far below its Graham number. Rather, Applied Materials is an interesting company because it meets Graham’s broader definition of quality.