Out of U.S.-based companies with market caps of $2 billion or more, Advanced Micro Devices, Inc. (NASDAQ:AMD) is the ninth-biggest winner of 2016. And drilling down to just the tech sector, AMD stock is the year’s single biggest winner.
Just a year ago, AMD was left for dead. The Sunnyvale, CA-based company appeared to have finally given up the ghost after years of underperformance.
But that’s all changed now.
AMD stock added more than 300% over the past year, and anyone fortunate enough to buy shares at $2 early in 2016 is now looking at a quintuple.
Faith in AMD finally bore fruit. Can the rally continue even after this monster move? Or is now a good time to take profits/and or wait for a correction?
AMD Stock Cons
Still Not Profitable: AMD last produced full-year profits in 2011. Over the past five years, it has consistently lost money. Often, in large quantities. On top of that, the company failed to produce positive free cash flow over the past five years. A company that can’t generate profits or cash flow will not survive all that long. Hence, AMD’s penny stock status for much of the past several years. AMD appears to be turning the corner. Revenues surged more than 20% in AMD’s most recent quarter versus the same period last year. Still, the company continues to operate with a negative net operating margin.
This shows that AMD is losing money, even before paying taxes and interest on its debt. And forward analyst estimates for 2017 suppose that the company will only produce marginal profits, with the forward price-earnings ratio still running near 100. AMD stock represents a turnaround story where the stock has already performed, even though the new business model isn’t proven yet.
Zen Launch: AMD stock has continued to surge over the past month, with shares rising from the $6s to above $10. Much of this enthusiasm centers around the launch of the new Zen technology. This offers AMD the opportunity to make a strong push back into the high-end CPU market. Intel Corporation (NASDAQ:INTC) has dominated this area in recent years. Should Zen launch well and pick up momentum, however, it could make serious inroads into both the server and gaming markets.
At this point, it’s worth considering that this upside may be fully priced into AMD stock. AMD’s launch party, titled New Horizon, for the Zen platform, will be hosted next week. AMD will show off the technology Dec. 13 in Austin. Investors who have been buying the stock ahead of this announcement may take profits afterward. And should anything disappoint with the launch, it could serve as a short-term rally killer.
Still Struggling in GPUs: The focus on Zen has made it easier to forget about AMD’s issues elsewhere. The most obvious might be in the graphic processing unit space. Here, Nvidia Corporation (NASDAQ:NVDA) serves as the primary competitor. And Nvidia is winning. Most recent quarterly results showed Nvidia with more than 50% year-over-year revenue growth. Nvidia generated more revenues from its GPU business alone than AMD earned across all business lines. And unlike AMD, Nvidia is very profitable.
Against Nvidia’s 60% growth rate in gaming, AMD showed just 10% year-over-year growth in its computing and graphics segment. And AMD’s division lost money. Yes, there’s a boom in gaming. But no, it’s not doing a whole lot for AMD’s financial results.
AMD Stock Pros
Moving Toward Higher-Margin Business: AMD’s problem has been profitability. It continues to produce adequate levels of revenue and enjoy sufficient market share to have the makings of a successful operation. Intel and Nvidia have gotten the lion’s share of the economic benefits, however, leaving AMD stock owners with just the scraps. This could (finally) change in 2017.
The Zen platform will give AMD the opportunity to steal much more profitable high-end market share from Intel. The server market offers AMD a particularly attractive opportunity, given Intel’s high-cost solutions there at present. Additionally, AMD’s new GPU may allow it to compete more effectively within the more profitable high-end part of the GPU market, rather than just selling mass-market chips for peanuts.
Relatively Good Balance Sheet: Despite AMD’s persistent troubles over the past few years, the company has maintained a decent balance sheet. The company’s long-term debt load has consistently run between $1.5 billion and $2 billion over the past five years. The company has responded to its ongoing fiscal losses by shrinking its assets. It has reduced its ownership in tangible things, such as machinery.
A company with more assets is better than one with fewer, all else held equal. Given AMD’s heavy reliance on licensing revenues and R&D-powered new technologies, an asset-light business model is better than a heavily indebted balance sheet. AMD has positioned itself to survive the ongoing unprofitable stretch and still have time for its R&D efforts to pay off.
Large Short Interest: The rise in AMD stock has made short sellers salivate. Bears are circling the company, thinking that after a quintuple, a fall must follow. They stand to make sizable profits if their intuition plays out. But the short sellers expose themselves to significant risk. In March, short sellers had a 135 million share position against AMD.
They covered their bets, shrinking the short interest to just 71 million AMD shares by late August. However, the saying once burned, twice shy doesn’t seem to apply to AMD short sellers. They’ve piled back into the stock, increasing their position by 20 million shares over the past three months. Short interest now sits at 14% of AMD’s float, offering substantial fuel for further rallies in AMD stock.
AMD stock represents a classic high-risk, high-reward bet on new technology. Advanced Micro Devices has a fat product pipeline. And over the next few quarters, we’ll see if those new products make a big splash, or end up disappointing.
AMD stock, however, trades at a level where the company needs to see vast success to power further gains. The stock isn’t at $2 anymore. There’s plenty that could go wrong for AMD over the next year, and at $10, there’s substantial downside if the story veers off track.
As of this writing, Ian Bezek was long INTC stock. He did not hold a position in AMD. You can reach him on Twitter at @irbezek.
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