ASML The Best AI Stock to Own or Avoid?

$ASML Holding NV(ASML)$

ASML’s Recent Price Decline

ASML is a stock I’ve discussed extensively on YouTube as one of the best AI-related investments in the stock market. Over the past year, the stock has declined by 32%, bringing it very close to my cost basis of $652 per share. If it drops below that level, I may consider averaging down, as I originally bought in during a deep-selloff. I continue to believe ASML is significantly undervalued—and I’m not the only one.

ASML’s Massive Share Buybacks Signal Confidence

ASML’s own management has been aggressively buying back shares, which is often a strong signal that insiders see the stock as undervalued. They have repurchased over €3 billion worth of stock, amounting to roughly 1% of the company’s total shares outstanding, and that was just in the first three months of 2024. This is particularly noteworthy because ASML hadn’t bought back any stock since April 22, 2024, making their renewed commitment to share repurchases all the more significant.

The Scale of ASML’s Buybacks: A Sign of Strong Conviction

Since late January, ASML has been buying an average of 90,000 shares per day. Looking at their most recent buyback report, we see consistent daily purchases in the range of 95,000 to 98,000 shares. If they continue at this pace, they could repurchase 3-4% of their total market capitalization by the end of the year. This level of buyback activity indicates strong confidence from management in the company’s future and aligns with my own view that ASML is currently trading at a significant discount to its intrinsic value.

Why ASML is a Unique Investment Opportunity

ASML’s Monopoly in Lithography

ASML is the undisputed leader in the lithography market, producing the highly specialized machines that semiconductor manufacturers rely on to produce advanced chips. With an estimated 92% market share, ASML operates as a near-monopoly in the industry. There are virtually no direct competitors capable of challenging their dominance, thanks to decades of massive investments in research and development.

Decades of R&D Created Insurmountable Barriers to Entry

Over the past 30 years, ASML has invested billions of euros in developing its cutting-edge extreme ultraviolet (EUV) lithography machines. These machines are essential for manufacturing the most advanced semiconductors, enabling smaller, faster, and more energy-efficient chips. The significant technological complexity and capital requirements involved in creating these machines have established incredibly high barriers to entry, effectively preventing any serious competition from emerging.

Alternative Technologies Are No Threat to ASML

A report from Fetch highlights this dominance, stating:

"We view alternative technologies as posing only a small and distant threat to lithography market leadership. All currently available alternative technologies, including nano-imprint lithography, are inferior in cost and yield for the mass production of advanced chips."

This underscores the critical role ASML plays in the global semiconductor supply chain. Rather than trying to pick which semiconductor company will develop the best AI chips or computing processors, investing in ASML provides broad exposure to the entire industry. Every major chipmaker—whether it’s NVIDIA, AMD, Intel, or TSMC—relies on ASML’s machines to manufacture their most advanced products.

ASML’s "Toll Bridge" Business Model

Why ASML is the "Toll Bridge to Innovation"

Legendary investor Warren Buffett often talks about investing in businesses that function as "toll bridges"—companies that control critical infrastructure or resources, forcing other businesses to pay for access. ASML perfectly fits this model. If the U.S. wants to bring semiconductor manufacturing back onshore and reclaim its leadership in chip production, there’s no way around it—they will have to buy ASML’s machines.

ASML’s Stunning Earnings Growth Despite Cyclicality

This business model has enabled ASML to grow earnings per share at an impressive 22% compound annual growth rate (CAGR) since 2014, despite the semiconductor industry’s cyclical nature.

Strong Demand Signals a Bright Future

In the most recent quarter, ASML’s net bookings surged from €2.66 billion to around €7 billion, signaling a strong pickup in demand. Semiconductor manufacturers are ramping up production, with major investments happening in the U.S., Taiwan, and other key regions. This suggests that demand for ASML’s machines is not slowing down anytime soon.

ASML’s Diverse and Resilient Revenue Streams

Machine Sales vs. Installed Base Management

While ASML’s core business revolves around selling new lithography machines, there is another important aspect of its revenue model that provides additional stability: installed base management.

A High-Margin, Less Cyclical Business Segment

Approximately 25% of ASML’s revenue comes from maintaining and servicing existing machines, including providing upgrades and replacing components. This segment is projected to grow at a 13% CAGR and is significantly less cyclical than the machine sales business. While demand for new machines can fluctuate with the semiconductor cycle, maintenance and servicing contracts provide a more predictable, recurring revenue stream.

Why ASML’s Revenue Mix Strengthens the Business This mix of high-growth and stable revenue sources makes ASML a unique and attractive long-term investment.

The Key Risk

ASML’s Declining Exposure to China The biggest risk facing ASML is its exposure to China. In 2023, China accounted for 47% of ASML’s shipments, but this has since dropped to 27%, primarily due to export restrictions imposed by the U.S. government. The U.S. is actively working to limit China’s access to cutting-edge semiconductor manufacturing technology, and ASML has been caught in the middle of this geopolitical battle.

ASML’s Long-Term Strategy to Reduce China Dependence ASML is aware of this risk and has adjusted its long-term guidance accordingly. By 2030, they expect China to account for just 20% of revenue, with increased sales in the U.S., Europe, and other regions compensating for the decline.

The Risk of China Developing Its Own Lithography Machines Another potential risk is China developing its own lithography machines. While Chinese companies have been attempting to do this for years, ASML’s decades-long technological lead makes it unlikely that China will be able to produce a competitive alternative anytime soon. Even if they do, I expect that the U.S., Europe, and South Korea will continue relying on ASML, limiting the impact on ASML’s overall business.

ASML’s Valuation and Price Target

ASML’s Current Valuation is Attractive

ASML currently trades at 26 times earnings, below its historical mean of 31x and far below its peak multiple of 52x. Historically, 27x earnings has been a strong buying point for the stock.

Projected Earnings Growth

Looking at ASML’s earnings growth, the company expects EPS to grow by:

• 24% in 2024

• 21% in 2025

• 19% in 2026

Given their aggressive share buyback program, achieving 20% EPS growth per year for the next five years seems very achievable.

Price Target Based on Earnings Growth

1. I project ASML’s 2025 EPS at $49.64

2. Applying a 27x multiple results in a 5-year price target of $1,340 per share, representing a 98% upside

3. Using a 31x multiple results in a target of $1,538 per share, a 130% upside

Conclusion: A High-Conviction Buy

ASML presents an incredible investment opportunity. With its near-monopoly position in lithography, strong secular tailwinds from AI and semiconductor growth, and a robust business model, I see significant upside over the next several years.