I have recently been asked by one of my partners about ASML and since I have always considered the company interesting, I dug in and did a brief analysis.
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Summary
ASML commands a dominant technological and market position but faces a cyclical industry, rising geopolitical tensions, and potential disruption from Chinese entrants. While demand for advanced chips should support long-term growth, valuation is high and both political and competitive risks warrant caution. Crucially the cyclicality of the semiconductor business and the overwhelmingly non-recurring nature of the revenue are not priced into the elevated multiple. Investors tend to extrapolate positive fundamentals with excessive optimism far into the future, when everything is going well and omit a fundamental understanding of the business.
At the current elevated valuation and with the risk/reward relationship being tilted to the downside, I will remain watching from the sidelines. As Peter Lynch, a very successful value investor that generated superior excess returns, advised investors to be cautious with P/E ratios when it comes to cyclical businesses, I consider it risky to invest at high P/Es in an environment of possibly elevated earnings. ASML, for now, will be stacked in the “too hard pile” (Buffett’s literal and metaphorical practice of slipping investment ideas outside of his circle of competence in a box labelled as “TOO HARD”) as I have no insights that would enable me to accurately prognosticate its future owner earnings.
Ex-post: My analysis pre-dates the announcement of Q2-25 earnings today. While positive fundamentals beating most expectations were published, the negative outlook of possibly not achieving growth in 2026 and slower growth in 2025, dragged the stock down by 7-8% at the time of writing. In 2025, ASML expects 15% growth — below the 30% threshold I consider necessary to justify its current valuation. This confirms my main concerns around the cyclicality of the business and the risk/return relationship currently being tilted towards the downside.
Guide to my analysis:
“+” positive points;
“-” negative points;
“=” neutral points;
“?” open points
Business Overview
- + ASML is the dominant player in semiconductor equipment with proprietary critical technology, especially for advanced lithography systems. The company holds a near-monopoly in Extreme Ultraviolet (EUV) lithography.
- Lines of Business
- DUV (Deep Ultraviolet Lithography): Used for most chip layers and legacy manufacturing, especially for less advanced chips or specific layers.
- Metrology and Inspection: Tools that ensure patterning accuracy and process control.
- EUV (Extreme Ultraviolet): Latest technology for the smallest, most advanced chip features.
- Future High-NA EUV: Next-generation lithography targeted for introduction by around 2032.
Competitive Landscape
- Demand Trends
- Semiconductor chip layers typically require different lithography methods. Every chip is manufactured using multiple lithography steps, each often requiring different resolution levels. Chips consist of hundreds of layers, most of which are patterned using Deep Ultraviolet (DUV) lithography.
- Most chip layers use DUV. It is sufficient for many applications, such as automotive chips (e.g. pressing the button to open car window).
- EUV is only required for advanced nodes (e.g., AI and leading-edge processors).
- Historically, >80% of sales are to Asia and 17% to the US (with the US share growing quickly).
- DUV Market
- + ASML: Dominant with estimated 60-90% market share; DUV machines sell for $5–$90m.
- = Nikon (Japan): Major DUV competitor with estimated 5-10% share.
- = Canon (Japan): DUV competitor and developer of other promising technologies like nanoimprint machines; estimated 5-10% share.
- ? SMEE (China): Leading Chinese DUV lithography equipment manufacturer, but still with a minor market share.
- EUV Market
- + ASML’s latest EUV machines sell for ~$400m each, and it remains the sole commercial supplier.
- + Nikon: Does not compete in EUV.
- – Huawei (China): Is at the forefront of China’s EUV efforts and currently testing domestic EUV devices using Laser-Induced Discharge Plasma (LDP)—a possible alternative to ASML’s technology of Laser-Produced Plasma (LPP) method for generating EUV light, aiming for advantages like simpler architecture, reduced footprint, and potentially lower production costs. If commercialized, the LDP technology that circumvents some of ASML’s established intellectual property could disrupt the market.
- – SMEE (China): Patent filings indicate ambitions to develop EUV, as part of the broader government-backed initiative.
- Competitive Advantages
- + Technological lead: proprietary technology with long development timeline e.g. EUV development took 20 years; few companies have the R&D and resources to compete.
- + Massive capital investment: Barriers to entry are extremely high due to R&D and manufacturing complexity (few companies have tried, but none have succeeded).
- ? Price power: in an interview with CNBC, ASML stated it must balance pricing power with Moore’s Law, ensuring customers can continue to shrink nodes affordably in a never ending cycle to shrink nodes.
Management
- + Experience: CEO Christophe D. Fouquet (appointed April 2024) has 15+ years experience at ASML and 25+ years in semiconductors.
- +/? Operational expertise: Fouquet’s previous roles in his leadership of EUV and business operations underpins the company’s current growth and technology edge, which is promising, but it is still too early to fully assess his tenure as CEO.
- – Owner-alignment: Insider ownership is low, i.e. the CEO holds only a minimal stake.
Key Risks
- -/+ Cyclical business vs. Structural growth drivers:
- – ASML is fundamentally a cyclical business:
- – Sales reflect the semiconductor industry’s investment cycles, influenced by technology adoption, end-market demand (e.g., for AI, smartphones, automotive), and macroeconomic conditions.
- – The semiconductor sector is highly cyclical. For example: Nvidia, whose primary manufacturer is TSMC, leans heavily on 5-6 major customers that are spending 25-30% of their annual revenue on capex and whose ad-driven spending is highly cyclical; but spending can quickly contract during downturns.
- + Structural long-term growth prospects:
- Despite cyclicality, long-term secular trends like AI, high-performance computing, and broad digitalization are expected to spur ongoing demand for advanced chips and lithography equipment.
- – ASML is fundamentally a cyclical business:
- – Revenue Model & Equipment Cycle
- – High share of non-recurring revenue and very long replacement cycles: 75%+ of sales come from core equipment sales, but machines last decades, particularly DUV systems are designed for exceptional longevity and rarely fully replaced, but instead maintained, upgraded, and often refurbished— ASML stated in 2022 c. 95% of those sold in 30 years still operate.
- – Recurring revenue: Service revenue, while rising, still is not the dominant revenue driver and remains 23% of sales in 2024 and 26% in Q1 2025.
- – Political/geopolitical:
- – US Trump administration pressured Dutch government to block shipments of EUV exports to China; only DUV machines are allowed.
- – New Chinese competition:
- – DUV: China is catching up, with 7nm chips (most advanced nodes possible without EUV) already in limited production.
- ?/- EUV: Newman (250522 on CNBC) CEO of Futurm Group, a research and advisory firm for high-tech, said its a long shot for China to develop own EUV machine. However, while it was previously thought China would lag 10-15 years behind in EUV, recent reports suggest Huawei’s trial production for an LDP system is slated for Q3 2025, with mass manufacturing targeted for 2026 (Li – Digitimes Asia, 250311). Matching ASML’s throughput, reliability and cost-effectiveness will take time. The path to mass production and widespread adoption of domestic EUV solutions in China faces significant technical, geopolitical and economic challenges, but successful Chinese LDP-based EUV lithography commercialization could significantly alter the global semiconductor landscape and threaten ASML’s near-monopoly in the long run.
Valuation
- – Current P/E ratio: 31x, implying earnings growth of ~30% over the next several years to justify the valuation, while earnings have actually been growing 23% most recently.
- – Cyclical risks: the high P/E is risky for a cyclical sector with the possibility of a slowdown, especially as AI-driven capex may be peaking. The duration and magnitude of the AI chip boom are uncertain, especially as we haven’t experienced a cycle in the AI industry, making earnings forecasts challenging—historic tech booms with increased competition and overinvestment (e.g., Dotcom bubble) show that early winners may not prevail long-term. I remain with more questions than answers, amongst others: Will the capex boom in the AI industry be a temporary massive jolt for the initial capacity being built? Going forward, how much capex will the majors be required to spend annually to maintain their technological lead?
- – The risk/reward balance is tilted unfavourably toward the risks making an investment at the current valuation less attractive.
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