KLA Corporation's (KLAC) Recent Decline: Navigating Sector Momentum and Geopolitical Headwinds

KLA Corporation (KLAC) has been a standout performer in the semiconductor equipment sector in 2025, delivering a year-to-date (YTD) total return of 57.03% compared to the S&P 500's 11.1% and the sector's 30.46%, as shown in KLA's Q3 results. However, the stock has recently experienced a steeper decline relative to both the broader market and its peers, raising questions about the sustainability of its momentum. This divergence reflects a complex interplay of sector-wide tailwinds and company-specific challenges, particularly around geopolitical risks and valuation pressures.

Sector Momentum: AI-Driven Growth and Record Capital Spending

The semiconductor equipment industry is on track for a historic year in 2025, with global sales projected to reach $125.5 billion-a 7.4% increase from 2024-driven by AI adoption and advanced node manufacturing, according to SEMI's forecast. Wafer fab equipment (WFE) sales, which account for the bulk of the market, are expected to hit $110.8 billion in 2025 as foundries and logic chipmakers invest in capacity expansions and process technology upgrades, per the SEMI report. KLA, a leader in process control and inspection tools critical for advanced nodes, has benefited from this trend. Its Q3 2025 results underscored this strength, with revenues of $3.06 billion and non-GAAP EPS of $8.41, exceeding guidance and reflecting robust demand in leading-edge logic and high-bandwidth memory (HBM) applications, according to MarketBeat's data.

The AI boom has further amplified demand for KLA's advanced packaging solutions, a segment the company expects to generate over $850 million in revenue in 2025, per Sowell Management commentary. This growth is underpinned by the need for heterogeneous integration in AI chips, where KLA's inspection and metrology tools play a pivotal role.

Geopolitical Headwinds: Export Controls and China Exposure

Despite these positives, KLA faces significant headwinds from U.S. export restrictions targeting China, which SEMI estimates account for 32% of its revenue. The revocation of Validated End-User (VEU) status for key Chinese manufacturers has created operational bottlenecks, with the company projecting a $500 million revenue reduction in 2025 due to export controls and reciprocal tariffs, according to a Monexa analysis. This decline is not unique to KLA-Applied Materials (AMAT) and Lam Research have faced similar challenges-but the magnitude of KLA's China exposure amplifies its vulnerability.

The Services segment, which includes maintenance and support for KLA's installed base, is also under pressure. Regulatory uncertainties have dampened customer spending, with growth expected to slow to 10% in 2025, below its historical mid-teens pace per the SEMI report. These challenges highlight the sector's sensitivity to geopolitical shifts, as companies balance near-term profitability with long-term market access.

Valuation Pressures and Earnings Dynamics

KLA's stock has traded at a premium valuation, with a P/E ratio of 35.02 and a PEG ratio of 3.62, based on MarketBeat data. While these metrics are justified by its strong free cash flow generation ($990 million in Q3 2025) and margin expansion (63% gross margin), they also introduce risk if earnings growth slows. Analysts project 1.58% earnings per share (EPS) growth for 2026, significantly below the 15.55% year-over-year increase expected in the current quarter, per MarketBeat. This disparity reflects investor skepticism about KLA's ability to sustain its recent performance amid macroeconomic volatility.

The recent 4.3% intraday rally following AMD's GPU deal with OpenAI illustrated the stock's sensitivity to sector sentiment; broader capital flows have shifted toward AI chip designers like Nvidia, leaving equipment makers like KLA and AMAT to navigate a more competitive landscape.

Historically, KLAC has demonstrated a notable post-earnings beat edge, with the stock outperforming the benchmark by 5.7% around day 11 and 8.3% by day 30, according to a backtest of 14 events from 2022 to 2025. The win rate exceeded 70% on several mid-to-late horizons, indicating a reliable pattern following positive earnings surprises. These findings suggest that while KLAC's valuation may appear stretched, its ability to consistently exceed expectations has historically translated into meaningful short- to medium-term outperformance.

Outlook: Balancing Growth and Risk

KLA's Q4 2025 guidance-$3.075 billion in revenue and $8.53 in non-GAAP EPS-suggests confidence in its ability to offset China-related headwinds, as noted in KLA's Q3 results. The company's $5 billion share repurchase authorization and 12% dividend increase further signal management's long-term optimism. Yet, the path forward remains fraught with uncertainty.

Investors must weigh KLA's dominant position in advanced manufacturing against the risks of a bifurcated global semiconductor market. While AI-driven demand for process control tools is likely to remain resilient, the company's exposure to U.S.-China trade tensions and its premium valuation make it a high-conviction holding. For now, the "Hold" analyst consensus reported by MarketBeat reflects this balancing act, as the market digests both the company's operational strengths and the broader geopolitical tailwinds shaping its industry.