Drop Advanced Micro Devices, Inc. (AMD) Stock. Here’s Why.

Advanced Micro Devices, Inc. (NASDAQ:AMD) shares are on a tear this year. Through Mar. 8, AMD stock is up close to 17%. In stark contrast, its two main rivals are down for the year. Longer-term, the opposite will likely occur.

Drop Advanced Micro Devices, Inc. (AMD) Stock. Here’s Why.

The hype surrounding Advanced Micro Devices stems from the exciting markets it serves.

Namely, it sells chips and technology that are integral in helping computers and video games run, and newer markets such as datacenters and artificial intelligence that help computing systems pursue machine-learning.

Unfortunately, AMD doesn’t make money selling its chips. In fact, it hasn’t in some time. Fourth-quarter and full-year 2016 results didn’t indicate its loss-making ways will end any time soon. The market is intrigued about the firm’s future prospects, but may have gotten ahead of itself with Advanced Micro Devices.

AMD stock has risen nearly seven fold from around $2 per share to above $13 in the past year. That is more than twice the performance of arch-rival Nvidia Corporation (NASDAQ:NVDA), which itself nearly tripled in price last year. After some initial skepticism, I have really warmed to Nvidia’s prospects, and the stock has come down in price. It currently sits back below $100 per share.

Advanced Micro Devices operates in some of the same markets as Nvidia. Last year, AMD reported $4.3 billion in sales; 54% of the top line stemmed from the processors, customized chip systems and related technology that form the guts of gaming consoles. This includes Microsoft Corporation’s (NASDAQ:MSFT) Xbox and Sony Corp (ADR)’s (NYSE:SNE) PlayStation.

Where Advanced Micro Devices Is Struggling

The remaining 46% consists of selling processors and chipsets that run desktops and notebooks. You could say that this business competes directly with Intel Corporation (NASDAQ:INTC), but the fact is Intel has been crushing AMD since about 2005 in this business.

Back in early 2006, AMD and Intel each had about 50% market share in the CPU market. Since then, Intel has steadily dominated the market and now controls 80% of the market. AMD’s share is down to roughly 20%.

There is speculation that Advanced Micro Devices is better competing with Intel lately. AMD’s chip business grew revenue 9% for the year, which is certainly respectable, and operating losses were cut in half to $240 million. Its gaming business reported more modest 5.4% growth and positive operating income of $283 million that was up 32% year-over-year.

Unfortunately AMD still lost close to $400 million, or $0.60 per share, for the full year. Free cash flow was positive, but not by much (about $13 million), for all of 2016. Management did sell some equity interests in ATMP JV that brought in $342 million, which it used to pay down debt.

For the coming year, Advanced Micro Devices committed “to grow[ing] annual revenue, expand[ing] gross margin and deliver[ing] non-GAAP net income.” That doesn’t instill a lot of confidence that profits are going to start coming in in a big way, but it expects about the same level of capital expenditures and has a decent chance at improving its annual cash flow production.

During its earnings conference call, management highlighted strong momentum in its gaming businesses, and positive developments with the Ryzen desktop processor, which it plans to launch this month. It also mentioned its datacenter business and its Zen chips. Intel is also aggressively pursuing this market, which helps serve the strong growth trends that are being driven by cloud computing.

AMD management also said it delivered on its goals to grow gaming, better compete in computer chips, grow profits and reduce debt. It stressed serving “adjacent markets” that include datacenters, and its Radeon systems are set to serve machine learning and artificial intelligence, though this was mentioned in much detail during the quarterly results.

Bottom Line on AMD Stock            

Advanced Micro Devices plans to host its annual investor day on May 16 and the company said it would provide more detailed guidance at that time. As it stands, analysts on average expect AMD to post 7 cents in profit this year, and 29 cents during 2018. Sales growth should average around 10% in each of these periods where the top line could reach an excess of $5 billion by the end of next year.

That doesn’t leave much profit to value the company based off either earnings or cash flow. Price to sales is reasonable at about 2.9x, which is well below the industry average of nearly 4x. But there just isn’t enough visibility to get excited about AMD stock’s prospects, or to reasonably conclude profits are going to take off any time soon.

Intel seems a much safer bet. It has extremely steady profit and cash flow generation, a reasonable valuation and a dividend yield that is close to 3%. Nvidia is much more richly valued, but the dip below $100 represents a buying opportunity if growth continues as expected. Nvidia is much more exposed to AI and chips that serve self-driving cars. For the year, analysts think Nvidia’s sales will jump 16% to above $8 billion.

As of this writing, Ryan Fuhrmann did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2017/03/advanced-micro-devices-inc-amd-stock-drop/.

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