Advanced Micro Devices, Inc. (AMD) Stock Is Maxed Out, So Get Out

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AMD stock - Advanced Micro Devices, Inc. (AMD) Stock Is Maxed Out, So Get Out

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If you want to learn about the “pop and drop” dynamics that accompany overvalued cult stocks, you don’t need to look any further than Advanced Micro Devices, Inc. (NASDAQ:AMD) and the chart of AMD stock since July 25.

Advanced Micro Devices, Inc. (AMD) Stock Is Maxed Out, So Get Out

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Advanced Micro crushed second-quarter estimates when it disclosed its report after the bell Tuesday, July 25. Revenue came in $60 million above expectations, while the company’s adjusted 2-cent profit was better than the breakeven quarter expected by Wall Street analysts. Thus, the quarter marked a return to profitability (albeit on a non-GAAP basis).

Growth came from all the right areas, with high-margin revenue growth outpacing low-margin revenue growth. Gross margins expanded. The operating expense rate fell. Debt was reduced. Cash was up.

That’s all pretty good news, so AMD stock jumped. It opened the next day, July 26, about 7% higher, and traded by as much as 11% higher. But then it faltered into the closing bell, finishing only 5% higher than its pre-earnings tape.

AMD stock chart

The declines continued the next day, and the day after that as well. Since that huge pop, the bleeding hasn’t stopped. Today, AMD stock trades around $13.20 — about 6% below its pre-earnings close.

Why? Because valuation ultimately matters, and Advanced Micro Devices is maxed out. The chipmaker is nothing more than a sideways stock for the foreseeable future.

The Advanced Micro Devices Growth Story

In my last article, I pointed out a bearish divergence in the stock prices of next-gen chipmakers AMD and Nvidia Corporation (NASDAQ:NVDA). The market has pushed both of these stocks markedly higher over the past 20 months. Since January 2016, AMD and NVDA are up 360% and 400%, respectively.

Both are outstanding performances, but underlying the difference is that Nvidia has continued to rally this year, while AMD stock has bounced around after an early-year rally. NVDA shares are up more than 45% since February 2017, while AMD is up just 10% — essentially putting it in line with the S&P 500.

Why the divergence?

Because AMD’s growth story, while encouraging, isn’t as huge as touted. Revenues improved by 18% in Q1, 19% in Q2 and are expected to rise 15% in Q3. That’s great growth, but it doesn’t touch Nvidia. NVDA — which has more exposure to secular growth markets including the cloud, artificial intelligence and autonomous driving — saw revenues rise 48% last quarter, with 37% growth expected for the current quarter.

Nvidia’s growth is expected to come in ahead of AMD’s this year, and while both will face tougher comparisons next year, Nvidia is expected to come out a little more “growthier” on those estimates, too. Perhaps most troubling is the five-year forecast, where Wall Street sees low-double-digit growth prospects for NVDA, but merely fractional for AMD.

However …

Margin Growth Isn’t Enough

On the positive side, it is good to see that the mid- to high-teens revenue growth at AMD is coming from the right places.

The Computing and Graphics segment, which carries with it a higher margin than the Enterprise, Embedded and Semi-Custom segment, saw revenues rise 51% last quarter. That high-margin revenue growth is driving gross margin expansion. Gross margins rose 2 full percentage points in the quarter. Long-term, management thinks they can get gross margins to as high as 40%.

Meanwhile, revenue scale is driving operating expense leverage. The opex rate fell again this quarter, continuing a multi-quarter trend of leverage. Management thinks they can get the opex rate all the way down to 26%.

All in, management thinks operating margins can hit 14% in the long-term. Operating margins were 4% last quarter, so that’s 1,000 basis points of margin expansion in the long-term.

That is entirely doable over the next five years given the favorable product mix shift and robust revenue growth. Assuming net profit margins also expand 1,000 basis points, that gets AMD to 11% net profit margins in five years.

But even if revenues grow at 10% per year over the next five years, that is only $6.9 billion in revenue. An 11% profit margin implies net earnings of about $750 million. Meanwhile, AMD currently has a market capitalization of about $12.5 billion.

We’re talking about a valuation of 16 times earnings that are five years out.

Bottom Line on AMD Stock

I’ve asked this question before, and so I will ask it again: What sort of multiple will the market award Advanced Micro Devices in five years?

At that point in time, margins will be close to maxed out. Revenues will be growing at 10% per year. Overall, profit growth at that point likely will be in low double digits.

Consequently, I can’t imagine the 2021 version of AMD earning a multiple much higher than 20 times. Considering that AMD stock trades at 43 times next year’s earnings, and 16 times realistic 2021 earnings, upside in a multiyear window seems limited.

Advanced Micro should be great for traders between now and then, as it likely will have some monster swings in it. But long-term investors should wait for a better opportunity to buy AMD stock, and people already sitting on heavy gains should consider cashing some of them in.

As of this writing, Luke Lango was long NVDA.


Article printed from InvestorPlace Media, https://investorplace.com/2017/08/advanced-micro-devices-inc-amd-stock-is-maxed-out-so-get-out/.

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