When investors shift funds into a certain sector, they often go with the biggest, most liquid names in the group. These bigger firms offer direct exposure to the anticipated favorable trends without the volatility often found with smaller industry players. So it’s curious to find that investors have moved headlong into semiconductor stocks during the past year — the Philadelphia Semiconductor index has risen +57% — while Applied Materials (Nasdaq: AMAT), a favorite name in past cycles, has risen a more moderate +29%.

This atypical underperformance is the result of pair of factors — and each of them look set to reverse course.

Tracking Applied Materials’ market share can be quite tricky. The company sells a range of equipment that is used in various stages of the chip development and production process. Investors need to become familiar with industry jargon to be able to track industry sales trends at a granular level. For starters, Applied Materials lost market share in the last few years to rivals such as Tokyo Electron. As a result, sales fell even more sharply in 2009 than at key rivals. Nevertheless, a combination of new products and improved sales execution has halted the market share erosion in recent quarters, and management recently spoke of market share gains at a recent meeting with analysts. Even if market share remains flat and doesn’t erode any further, the company is poised for fairly robust sales growth as chip makers start to re-invest in the equipment needed to design and make state-of-the-art semiconductors.

We are now entering the boom phase in a notoriously boom-or-bust industry. Applied Material’s sales fell from $8.1 billion in fiscal 2008 to just $5.0 billion in 2009. Management has noted a strong rebound underway, and after a recent boost in guidance, it thinks sales in fiscal 2010 will exceed $8 billion, perhaps reaching $8.5 billion. Industry analysts think annual sales could reach $10 billion by fiscal 2011. Equally important, Applied Materials has embarked on aggressive cost-cutting, so the company should squeeze out more profit in this next cycle. Management expects the benefits of recent cuts to steadily boost margins during each of the next five quarters. In another shareholder-friendly move, management announced a $2 billion stock buyback plan, which could remove nearly 10% from the existing share count.

The company has another perception problem with investors: a decision to move into the solar power industry, which has not generated any meaningful profits yet. The solar segment is a bit Jekyll-and Hyde for the company. Applied Materials is seeing solid demand and impressive profit margins for its equipment focusing on the production of traditional crystalline solar panels. The Sunfab division, however; which focuses on less-efficient thin-film solar panels, has been a drain on the coffers. Although the shift into solar may prove to be prescient over the long haul, management is throttling back its investment in the near-term, which should create far less drag on the bottom line.

The exposure to the more dynamic end of the solar power industry could help boost sales and profits in coming years, as should a push into equipment that helps produce flat panel displays. But the important question for investors is whether the current spending rebound in the core semiconductor business will last several years or prove to be short-lived. Historically speaking, these cycles tend to last three to four years, and we’re only several quarters into the up leg of the cycle.

If the bears are correct, and spending is likely to be muted, then shares probably have only a small amount of upside. But if the cycle lasts several years, Applied Material’s leaner cost structure and lower share count could power a steady bottom-line expansion into 2011 and 2012 with per share profits coming in around $1.35 by fiscal 2012. If you apply a multiple of 15 times earnings, shares could approach $20 — some +50% higher from recent levels.