Potential value play Lam Research (Nasdaq: LRCX) makes processing equipment for other companies who make semiconductors. Although it doesn't actually produce memory chips or semiconductors itself, it is set to encounter slowing sales due to falling prices for memory chips. These falling prices mean manufacturers are delaying orders for new equipment which will reduce the sales of firms such as Lam Research. The end result is investors may want to avoid buying any company that is even remotely connected to the memory game, at least for now.

A Value Play
Lam Research sports many of the signs that value investors seek in stocks before making a commitment. For example, the company presently has a P/E ratio under 12 and a PEG ratio of 0.60. For fans of Joel Greenblatt's approach to valuing stocks, the company's return on working capital is in excess of 100% and their earnings yield is over 16%.

Cash flow is another key measure used by many investors to analyze their potential investments. For the last four quarters, free cash flow margin, a measure how much free cash flow a firm's sales generate, for Lam Research is 22%. This is very good. In addition Lam's free cash flow yield is 7.8%. Free Cash flow yield is the amount of free cash flow per share based on the current value of the stock. So, Lam is generating a lot of excess cash for now. But what about the next year?

Memory Manufacturers Delaying Capital Expenditures
According to various reports, current pricing for some NAND flash memory is 15% to 20% below production costs. MarketWatch reports that falling DRAM prices are causing memory chip makers to have one of their worst quarters. As prices fall further than expected, the memory manufacturer's finances are put under undue pressure. One of the first actions these companies can take to conserve cash is to reduce their capital expenditures for new equipment.

According to Citigroup, a "funding gap" has developed as memory EBITDA will fall significantly below capital expenditures. If this happens, it will be only the third time in the past 15 years in which this situation has occurred. In the past when this happened, expenditures on new capital equipment fell the following year. This means we can expect significantly lower capital expenditures in the near future by the manufacturers of memory chips. (To learn more, read A Clear Look At EBITDA.)

Sales Likely to Slow
For Lam Research, memory is the largest market segment making up 78% of the company's business as of the end of the quarter March 25, 2007. Any slowing in the number of orders from semiconductor memory manufacturers will hurt Lam Research's sales.

As confirmation of this, on June 28, 2007, Novellus Systems (Nasdaq: NVLS) warned that its second-quarter financial results will come in at the low-end of expectations due to weakening demand for equipment. Shortly thereafter, a report by Caris & Company's Ben Pang states that Applied Materials' (Nasdaq: AMAT) etch division has been notified of a reduction in orders from Samsung for AMAT's fiscal fourth quarter ending in October.

Cation Required
Given these factors, it is reasonable to assume that Lam Research will also encounter slowing sales in the coming months. While the company has performed well recently, and it is guiding toward the high end of the range, investors should be realize that this is likely the peak in sales for this cycle.

Investors should be wary of taking any position in any semiconductor equipment manufacturers such as Lam Research that provide equipment for the memory manufacturers. While Lam possesses excellent value indicators, the company's customers (memory manufacturers) are encountering a turbulent pricing environment. Therefore, it might be worthwhile for investors to delay taking a position until the memory market stabilizes and equipment orders are likely to pick up.

Looking to cook up a market-stomping stock portfolio? Check out our FREE report "7 Ingredients to Market Beating Stocks" and get started right now!

Related Articles
  1. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  2. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  3. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  4. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  5. Investing News

    Chipotle Served with Criminal Probe

    Chipotle's beat muted expectations and got a clear bill from the CDC, but it now appears that an investigation into its E.coli breakout has expanded.
  6. Stock Analysis

    Analyzing Sprint Corp's Return on Equity (ROE) (S)

    Learn about Sprint's return on equity. Find out why its ROE is negative and how asset turnover and financial leverage impact ROE relative to Sprint's peers.
  7. Stock Analysis

    Why Alphabet is the Best of the 'FANGs' for 2016

    Alphabet just impressed the street, but is it the best FANG stock?
  8. Investing News

    A 2016 Outlook: What January 2009 Can Teach Us

    January 2009 and January 2016 were similar from an investment standpoint, but from a forward-looking perspective, they were very different.
  9. Mutual Funds & ETFs

    3 Vanguard Equity Fund Underperformers

    Discover three funds from Vanguard Group that consistently underperform their indexes. Learn how consistent most Vanguard low-fee funds are at matching their indexes.
  10. Investing News

    Alphabet Earnings Beat Expectations (GOOGL, AAPL)

    Alphabet's earnings crush analysts' expectations; now bigger than Apple?
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
Trading Center