Micron Trades at Just 5 Times Forward Earnings. Here's Why the Market Doesn't Trust the Memory Supercycle Yet.

Many tech stocks have soared in recent years thanks to the rise of artificial intelligence (AI). One is computer memory manufacturer Micron Technology (NASDAQ: MU), whose shares skyrocketed over 600% in the past 12 months through the end of July.

Despite this amazing run, Micron's share price valuation looks cheap, given the stock's forward price-to-earnings ratio of about 5. That's around a low point for the past year.

In addition, Micron shares are down from their 52-week high of $1,255 reached in June. This is rooted in market concerns that the memory supercycle has peaked, resulting in a stock sell-off. But has it, or will Micron continue to benefit from AI-driven demand? Here's a deeper look into the situation.

Image source: Micron Technology.

Micron and the state of the memory sector

In Micron's earnings report for its fiscal third quarter ended May 28, CEO Sanjay Mehrotra noted that customer hunger for computer memory continues to outpace industry supply, stating, "We expect tight conditions to persist beyond calendar 2027 as a result of AI-driven demand across all segments coupled with structural supply constraints."

This situation resulted in the company achieving record fiscal Q3 revenue of $41.5 billion, up from the previous year's $9.3 billion. The massive sales growth contributed to fiscal Q3 diluted earnings per share of $24.67, a jaw-dropping increase over $1.68 in the prior year.

However, supply constraints mean limited revenue growth ahead. To combat this, Micron raised its planned investment in U.S. manufacturing facilities to more than $250 billion and is ahead of schedule in constructing a New York fab, the largest semiconductor manufacturing site in U.S. history, according to the company.

Micron's future fate

By expanding its manufacturing capabilities, Micron risks oversupply in the future. Historically, the semiconductor industry goes through cycles in which a boom period gives way to a downturn as customers slow their buying, leading to excess inventory, price drops, declining revenue, and shrinking margins. Anticipating this, Wall Street investors are selling Micron shares now before an inevitable industry decline strikes.

Another factor in Micron's sell-off is the initial public offering of China-based ChangXin Memory Technologies in July. This company could make memory products at a cheaper price point, undercutting Micron and possibly taking business away.

Despite these concerns, the nature of the current memory supercycle injects a key difference into the picture. In the past, a surge in memory demand was driven by human need, such as people purchasing smartphones or the growth in laptop sales as remote work expanded during the COVID-19 pandemic.

This time, artificial intelligence is the driver. As AI models increase in sophistication, their performance depends on memory. With around 3,000 new data centers being planned or constructed in the U.S., Micron's products have the potential to see ongoing demand for years.

Consequently, the AI-fueled memory supercycle may not have peaked yet. If so, the current stock sell-off is happening prematurely, which means Micron shares are now trading at an attractive valuation.

Robert Izquierdo has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Micron Technology. The Motley Fool has a disclosure policy.