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Should You Buy Advanced Micro Devices, Inc. (AMD) Stock? 3 Pros, 3 Cons

Why you might want to ignore Goldman's negative call, but don't fall in love with AMD stock either

I last covered Advanced Micro Devices, Inc. (NASDAQ:AMD) in December. At the time, I suggested that AMD stock still had promise. However at $10 per share, the stock came with as much risk as upside.

Should You Buy Advanced Micro Devices, Inc. (AMD) Stock? 3 Pros, 3 Cons
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Well, at least for now, Advanced Micro Devices has managed to silence the doubters, myself included. Shares have rallied as much as 50% so far in 2017.

Improving trends in the PC market and better supply chain checks have further supported the bull case for AMD stock. However, Advanced Micro Devices stock has gone in reverse over the past week, as Goldman Sachs threw some cold water on the upbeat atmosphere. Is this dip worth buying, or should we heed Goldman’s call to avoid AMD here?

AMD Stock Cons

Goldman Call: AMD stock was trading around $14.50 for most of the past week. However, Goldman Sach’s initiation with a sell rating sent the stock tumbling to as low as $13 on Thursday.

Goldman’s analyst Toshiya Hari said that Advanced Micro Devices’ fundamentals are improving; however, that this is already more than priced into AMD stock. Hari also suggested that investors watch competitive pressure from Intel Corporation (NASDAQ:INTC) and Nvidia Corporation (NASDAQ:NVDA) closely.

While Goldman is clearly a top-tier analyst shop, in Advanced Micro Devices’ defense, I’d note Hari’s bearish case isn’t particularly novel. And unlike recent AMD stock bull calls, Hari didn’t back up the bearish tone with compelling channel checks or other specific warning signs.

Really Tenuous Valuation: Just about everyone agrees that Advanced Micro Devices was severely mispriced when it traded under $5 last year. Even bears aren’t aiming that low anymore. However, from a valuation perspective, things are getting difficult to justify in the other direction.

On a pure earnings basis, AMD hasn’t earned a net profit since 2011. Its peak diluted earnings for any one year since the turn of the century is just 66 cents a share, implying a 20x price-to-earnings ratio even if it got back to its prior peak earnings. And even that overstates the company’s potential, since management has allowed the share count to balloon in recent years. The company had 547 million shares outstanding a decade ago, but it has now reached almost hit a billion today. Dilution does matter.

Intel Will Strike Back: And while AMD’s competitive position is improving, Intel is still dominant. It’s hard to argue that Advanced Micro Devices will hit new record high profits in the current technological environment; and that’s pretty much the only way you can justify today’s stock price. The problem for AMD stock is a simple one, the company tends to be in perpetual catch-up mode with Intel.

Yes, Ryzen has pulled mostly even with Intel’s current tech generation, though perhaps not on a video gaming basis. However, Intel is already developing its next-gen architecture that will likely allow it to pull way back ahead of Advanced Micro Devices. Making matters worse, Intel’s new-gen chips will likely cause backward-compatibility problems for programmers, causing AMD’s current line of tech to become obsolete more quickly.

AMD Stock Pros

Ryzen Launch: The company’s long-awaited Ryzen 7 chip has launched over the past month. This means that next quarter will be the first showing revenues from the new hardware line. While it’s too early to tell how well AMD will be able to steal share from a long-running Intel stronghold, with an up-to-50% price advantage versus Intel’s top-tier Core 7 chips, there’s substantial opportunity.

Ryzen’s launch did hit some initial bugs. One of these was a performance issue that impacted operations within Windows 10. However, the company was quick to work on this issue, and announced an upgrade this week offering as much as 21% gameplay performance improvements for Ryzen. Ryzen already competed well with Intel’s chipsets on application performance, and now they’re cutting the gap for video as well. Look for Ryzen to generate substantial revenues later on in 2017 as bugs are ironed out and momentum accelerates.

Trapped Bears: AMD stock has seen high short interest for many months now. Bears mounted huge short positions against the company at the lows, before taking some off as the share price rallied. In August 2016, the company’s short interest had dropped to 70 million shares, suggesting shorts were finally giving up on the idea. However, by year-end, this had climbed back up to 86 million shares short, which was already a high figure.

Incredibly, while AMD stock has surged in 2017, shorts are continuing to up their positions. As of the latest data from March, shorts now hold a 116 million share position — a $1.5 billion bet against Advanced Micro Devices. That’s a rather dangerous position as the stock continues to rally and Ryzen ramps. If one were conspiracy-minded, he or she might suggest the Goldman bearish call was well-timed to aid struggling bears. In any case, huge short interest remains a powerful catalyst for a further rally in the stock.

S&P 500 Inclusion: There is another factor adding to AMD stock’s recent momentum. The S&P 500 Index officially added it to its 500 member companies last month. This forces a huge amount of buying into the stock. It’s a reversal from 2013, when the S&P removed AMD from the index due to its declining market cap. What does it mean for the stock?

At Vanguard alone, $438 billion is invested in funds tracking the S&P 500 index. The SPDR S&P 500 ETF Trust (NYSEARCA:SPY) adds another $240 billion in S&P 500-linked assets, and the figure probably easily tops a trillion dollars once other smaller funds are included. That means that even if Advanced Micro Devices is a small position within the S&P 500 funds, passive investors have allocated hundreds of millions of dollars into the company simply due to its newfound index status. The short sellers are fighting a massive tide of money moving into the company. And at least for now, they’re losing.

Verdict on Advanced Micro Devices

AMD stock is a classic momentum play. Investors are powering the stock higher more on technical factors and hopes of future results than anything tangible today. These sorts of stocks are highly risky, as the price can collapse when momentum wanes. But for now, the majority of factors still seem to support the bullish case and fading the negative Goldman opinion. Just don’t hold the position too long if you’re making a momentum trade.

At the time of this writing, Ian Bezek owned INTC stock. You can reach him on Twitter at @irbezek.

Article printed from InvestorPlace Media,

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