During the California gold rush, many miners went bankrupt. However many merchants who were selling picks and shovels became rich.
Most investors recognize that the gold rush is on in 5G and artificial intelligence. The gold rush is also on in automotive electronics. Just take a look at a massive move in Tesla’s TSLA, -0.50% stock. (See this comparison of Tesla and other tech stocks and this analysis of Tesla’s share-price movement.)
If you could buy only one stock to take advantage of all of these trends without worrying about who would succeed, what would it be? Let’s explore with the help of a chart.
Note the following:
• 5G and artificial intelligence are huge users of semiconductors.
• In addition to the gold rushes stated above, there are more gold rushes in IoT (Internet of Things), consumer devices, renewable energy, power management and data centers.
• The picks and shovels for the present-day gold rushes are semiconductors.
• Picks and shovels were easy to make; semiconductors are increasingly becoming more complex.
• Applied Materials is a vendor of equipment used in semiconductor manufacturing.
• Applied Materials is a second derivative, and semiconductors are the first derivative of the gold rushes.
• There is an advantage to a large second-derivative semiconductor company such as Applied Materials. For example, Intel INTC, +0.04% was big in data centers and Advanced Micro AMD, +1.05% wasn’t much of a factor. When AMD stepped up with new designs, it started eating Intel’s lunch.
Another example is Nividia NVDA, +6.80%, which has reported excellent earnings. In our analysis at The Arora Report, Nvidia has a one-year lead in many facets over its competitors. However, prudent investors should be concerned not only about potential rewards but also potential risks. How long will Nvidia be able to maintain its lead? Take a look at Nvidia’s chart and you will see it has gone parabolic.
Start your analysis with Arora’s Second Law of Investing and Trading: Nobody knows with certainty what is going to happen next in the markets. In your risk analysis, ask yourself the following question, “How would the chart look if Nvidia started losing its lead?” You could easily lose 50% to 80% of your money.
In contrast to the examples given above, Applied Materials has relatively low risks in the long term.
• The chart shows a nicely upward sloping trend line. This is a positive.
• The chart shows a new trend line with a higher slope that started forming last year. This is a positive.
• The chart shows that the recent pullback was shallow. This is a positive.
• The chart shows that during the pullback, the accelerating trend line held. This is a positive.
• The chart shows that Applied Materials reported good earnings.
• Earnings were better than consensus and whisper numbers.
• The chart shows a technical breakout for Applied Materials stock. This is a positive.
• The chart shows the stock breakout occurred on heavy volume. This is a positive.
• RSI shows that Applied Materials stock is overbought but there is room to run.
• When a stock with steadily rising trend lines breaks out like Applied Materials has done, RSI should be used only for tactical purposes and not for strategic stock selection.
• The chart shows a cup and handle pattern. This is a positive pattern in the stock market especially when a breakout occurs on heavy volume.
•Semiconductor stocks have outperformed the Dow Jones Industrial Average DJIA, -0.17%, the SPDR S&P 500 ETF SPY, -0.04% and the Invesco QQQ Trust QQQ, -0.01%, which tracks the Nasdaq-100 Index NDX, +0.02%.
Megacap tech stocks
Apple is an obvious user of semiconductors. Many investors are oblivious to the fact that other megacaps are also huge users of semiconductors in their data centers. These megacaps are making significant progress in artificial intelligence and machine learning.
To gain an edge in megacap technology stocks and semiconductor stocks, consider using segmented money flows.
The U.S. dominates the semiconductor industry, and therefore China is highly dependent on U.S. companies. During the trade war, President Trump effectively used the U.S.’s position in semiconductors as a Sword of Damocles. It is natural for China to try to get out of this situation.
Sooner or later the coronavirus will run its course. When China gets in the mode of increasing its semiconductor abilities, Applied Materials will benefit.
When and how to buy
This stock market is controlled by the momo (momentum) crowd. If you have drunk the Kool-Aid of the momo crowd, then it is real simple — buy shares of Applied Materials and keep in mind that semiconductor stocks are very volatile.
What if you are a prudent investor? Then you need to bring significant sophistication to buying, holding and managing this stock. The chart link above shows the Arora buy zone.
Is there any advantage to being prudent anymore? Applied Materials’ stock is carried in our Model Portfolio from an average buy price of $16. Since our original buy, the stock has fallen numerous times into our newer buy zones, giving investors excellent opportunities. Often when momo crowd was losing money and their stops were hitting, we were buying the stock. The answer to the question asked at the beginning of this paragraph is yes — in the long term you will generate higher risk-adjusted returns.
Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article or may take positions at any time. Nigam Arora is an investor, engineer and nuclear physicist by background who has founded two Inc. 500 fastest-growing companies. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at Nigam@TheAroraReport.com.