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This Under-the-Radar Chip Stock Is Up 350% This Year. Here's Why it Could Go Even Higher.

If you're like most investors, you probably haven't heard of ACM Research (NASDAQ: ACMR).

The company makes single-wafer wet cleaning equipment for semiconductor manufacturers, and it's one of the best-performing under-the-radar stocks this year. The stock has surged 352% year-to-date, and is up a whopping 1,390% since its 2017 IPO. Still, this stock is only covered by a handful of Wall Street analysts and gets almost no press in the financial media. Aside from its stellar returns, there are a number of other reasons you may want to take a closer look at this semiconductor juggernaut.

Image source: Getty Images.

Unlike many of the high-flying SaaS stocks today, for example, ACM's stock performance looks justified from its fundamentals. Revenue jumped 44.1% to $107.5 million last year, and the stock trades at a reasonable price-to-sale ratio of 15. The company is solidly profitable. Last year, it generated $19.5 million in net income, or $0.99 per share, on a generally accepted accounting principles (GAAP) basis, triple what it generated the year before, giving it a profit margin of 18%, a sign of pricing power and competitive advantage. The stock currently trades at a price-to-earnings ratio of 73, again significantly cheaper than some of the most known SaaS stocks like Zoom Video Communications or Shopify.

Perhaps the best explanation for the stock's massive returns since its November 2017 IPO is that the company regularly trounces Wall Street estimates. The chart below shows how its earnings results have compared to the consensus forecasts.

Quarter Result Estimate Surprise
Q4 2017 $0.22 $0.09 144%
Q1 2018 ($0.04) ($0.09) 55%
Q2 2018 $0.19 $0.09 111%
Q3 2018 $0.23 $0.05 360%
Q4 2018 $0.16 $0.09 78%
Q1 2019 $0.14 ($0.01) N/A
Q2 2019 $0.26 $0.12 117%
Q3 2019 $0.53 $0.20 165%
Q4 2019 $0.23 $0.10 130%
Q1 2020 $0.11 $0.04 175%

Source: Etrade.

As you can see, ACM has consistently outpaced the experts' view by a wide range. If it can keep that up, the stock will almost certainly see more strong gains.

How ACM makes money

ACM is based in California, but the bulk of its operations take place in China, where it manufactures its single-wafer cleaning tools and where its biggest customers are located. The company owns 285 patents in several countries, and has proprietary technologies that it considers to be the most advanced in the industry. It sells front-end cleaning systems to chip-makers for $2 million to $5 million, and makes advanced packaging tools for back-end processes like coating and developing that are priced between $500,000 and $2 million.

The company's selling strategy has been to win over leading chip manufacturers like Yangtze Memory Technologies and use that to attract other manufacturers to buy its equipment. So far, that strategy appears to be working based on its revenue growth, along with the fact that the percentage of revenue coming from its biggest customers has steadily declined, though its top three customers still accounted 74% of its revenue last year.

About half of ACM's revenue is absorbed by the direct costs of manufacturing, including labor and material, and it spent 12% of revenue last year on research and development, helping to create a pipeline of new and innovative products and enhancements.

The growth path

ACM just broke ground on its new facility in Shanghai's Lingang Special Area, a 1 million square foot plant that will help the company scale up production in order to meet increasing demand, and helping it expands its market outside of China and the surrounding region as it targets North America, Western Europe, and Southeast Asia.

According to Gartner, the market for global wafer cleaning equipment was worth $2.6 billion in 2019, and ACM estimates its products can serve more than half of that market. In other words, based on the addressable market, the company could grow its revenue by at least 10 times, and likely more as the market expands with the rollout of 5G telecommunications and the introduction of other technological innovations over time.

Why ACM Research could be a long-term winner

ACM operates in an industry with high barriers to entry, as it's expensive and time-consuming to build the factories to manufacture wafer-cleaning equipment and develop the technology to do so competitively. There are also high switching costs, as chip-makers generally stick with the cleaning equipment providers they started using unless their equipment performs poorly.

ACM's proprietary technology gives it a competitive advantage over rivals that use jet spray technology, and it also has an edge over other companies that use conventional megasonic technology, which ACM believes underperforms its technology like Space Alternated Phase Shift (SAPS). According to ACM, SAPS has been shown to be more effective at removing random defects on wafers than jet spray or conventional megasonic technologies.

ACM's cleaning tools are used for a wide variety of chips, including foundry, logic, and memory, so the company functions like a picks-and-shovels play in the semiconductor industry -- an industry that is likely to see steady growth as the internet of things evolves, with automobiles, appliances and industrial equipment increasingly becoming computerized.

Revenue at the cleaning specialist slowed to 18% in the first quarter due to the impact of COVID-19, but the company still expects the top line to grow 21%-40% for the year and reach $130 million-$150 million.

Despite the stock's run-up, this is a small-cap play, valued at $1.5 billion today -- so it could still be a multi-bagger from here if the company executes on the opportunity in front of it.

ACM has an excellent growth track record, is highly profitable, and has a history of crushing Wall Street estimates. Its technology appears to have an edge over that of the competition, and the company still has a considerable market opportunity to penetrate. For growth stock investors, there's a lot to like here.

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Jeremy Bowman owns shares of ACM Research, Inc. The Motley Fool owns shares of and recommends Shopify and Zoom Video Communications. The Motley Fool recommends Gartner and recommends the following options: short August 2020 $130 calls on Zoom Video Communications. The Motley Fool has a disclosure policy.


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