KLAC's Underperformance Amid Market Gains: Strategic Risks and Valuation Misalignment in the Semiconductor Sector

KLA Corporation (KLAC) has defied the broader market's optimism in 2025, with its stock lagging behind gains in the S&P 500 and the semiconductor equipment sector. Despite reporting record Q3 2025 revenue of $3.06 billion-29.8% year-over-year growth-and a non-GAAP diluted EPS of $8.41, according to KLA's Q3 2025 release, the stock has underperformed. This divergence raises critical questions about strategic risks and valuation misalignment in a sector otherwise buoyed by AI-driven demand. Historical backtesting of KLAC's earnings events from 2022 to 2025 reveals that the stock has exhibited a persistent positive drift after earnings releases, with average excess returns peaking at +9.8% near the 28th trading day post-announcement (backtest exercise). However, short-term effects (≤5 days) remain statistically insignificant, and win rates improve steadily from ~60% at 5 days to ~70% around 26 days.

Strategic Risks: Geopolitical Headwinds and Sector Cyclicality

KLAC's exposure to geopolitical tensions, particularly U.S.-China trade dynamics, remains a significant drag. China accounted for 33% of KLAC's FY2025 revenue, as discussed in the Q3 2025 earnings call, but export controls and reciprocal tariffs have projected a 15–20% revenue decline in the region for 2025, according to a Monexa analysis. These restrictions, part of broader U.S. efforts to curb advanced semiconductor technology transfers, have disrupted KLAC's services business and supply chains. For instance, renewed export curbs in late 2025 triggered a 2.8% single-day stock drop, underscoring the sector's vulnerability to regulatory shifts.

Compounding these risks is the semiconductor equipment industry's inherent cyclicality. While KLAC's free cash flow margin of 33.5%, according to StockStory, and $990 million in Q3 2025 free cash flow reported in that release reflect operational strength, analysts caution that demand for process control tools could wane if global chip investments slow. Morningstar analysts, for example, note that KLAC's high debt-to-equity ratio of 1.52 (reported by StockStory) amplifies its sensitivity to downturns.

Valuation Misalignment: A Tale of Two Narratives

KLAC's valuation metrics diverge sharply from sector averages. As of Q3 2025, the semiconductor equipment sector trades at a TTM P/E of 64.16, per CSIMarket sector data, while KLAC's P/E stands at 36.27, according to KLAC financial ratios, a 43% discount. Similarly, the sector's P/B ratio is 6.97, based on NYU price-to-book data, compared to KLAC's 30.99 per StockAnalysis. This misalignment has sparked debate among analysts.

On one hand, bullish investors argue that KLAC's premium pricing is justified by its leadership in advanced packaging and AI-driven process control. The company's advanced packaging revenue is projected to exceed $850 million in 2025, as noted in that KLA release, and its ROIC of 36.84%-discussed during the earnings call-underscores efficient capital deployment. Analysts like Edward Yang (Oppenheimer) have upgraded KLAC to "Outperform," as highlighted in a Nasdaq article.

On the other hand, skeptics view KLAC as overvalued. A DCF model estimates its fair value at $929.68 in a Sahm Capital analysis, yet the stock trades at $909.86 per that same analysis, suggesting limited upside. Morningstar analysts, meanwhile, maintain a $670 fair value estimate (reported by StockStory), arguing that KLAC's cyclicality and debt load justify a discount. The company's recent $5 billion share repurchase authorization and 12% dividend hike, detailed in the Q3 release, may further strain financial flexibility during downturns.

The Path Forward: Balancing Growth and Risk

KLAC's strategic investments in R&D ($338 million in Q3 2025, per the Q3 release) and geographic proximity to key customers (e.g., its new Wales facility discussed on the earnings call) position it to capitalize on AI and high-bandwidth memory trends. However, its reliance on volatile markets like China and its elevated valuation multiples relative to peers like Applied Materials (AMAT) necessitate caution, according to a Nasdaq comparison.

For investors, the key question is whether KLAC's growth in leading-edge technologies offsets its geopolitical and cyclical risks. While the company's 30% year-over-year revenue growth in the March 2025 quarter is noted in a MarketBeat report, the sector's high P/E of 64.16 suggests investors are pricing in aggressive long-term growth. KLAC's lower multiples may reflect skepticism about its ability to sustain this pace amid regulatory headwinds.

Conclusion

KLAC's underperformance in 2025 highlights the tension between its strong operational execution and the strategic risks of operating in a geopolitically charged, cyclical sector. While its valuation appears undemanding relative to peers, the company's exposure to China and its debt load warrant careful scrutiny. For now, KLAC remains a compelling case study in the delicate balance between innovation-driven growth and macroeconomic fragility.