Why the Selloff in Advanced Micro Devices, Inc. Stock Is Warranted

When a stock fails to pop after reporting better-than-expected numbers and delivering above-consensus guidance, that is usually a surefire sign of a maxed-out valuation. I think that is exactly what we have with Advanced Micro Devices, Inc. (NASDAQ:AMD), the once-loved chip maker whose stock is getting beaten up after the company reported better-than-expected third quarter numbers.

Why the Selloff in AMD Stock Is Warranted
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But this is nothing new for the stock. In fact, AMD has just been range bound for most of 2017. Since a big pop in February, the stock is actually down 8%.

Meanwhile, the S&P 500 is up 11% in that time frame, the NASDAQ-100 is up nearly 17%, and its main competitor, Nvidia Corporation (NASDAQ:NVDA), is up 65%.

The market is trying to say something here, and it’s not all that positive for AMD stock. The harsh reality is that the Advanced Micro Devices growth story is overhyped, the stock is overvalued, and the narrative of perpetual market share gains against Intel Corporation (NASDAQ:INTC) is now broken.

What does all that mean? Stay away from AMD.

Reconciling a Good Quarter With Overhyped Expectations

By most standards, AMD had a pretty good quarter.

Both revenue and AMD earnings came in better than expected. Revenue growth came in at 26%. That is far better than the high-teens revenue growth rate the company has posted over the last several quarters. Moreover, the elevated mid-20s growth rate is here to stay. Management is guiding for roughly 26% revenue growth again next quarter.

The Street was looking for about 21% year-over-year growth next quarter.

The growth is coming from all the right segments. The powerful portfolio of Ryzen CPUs helped drive 74% revenue growth in the Computing and Graphics segment. Server revenue also grew nicely thanks to some EPYC sales ramp. This ramp will continue as hyper-scale data centers increasingly adopt and deploy EPYC processors.

Already, three of the seven big hyper-scale data-center providers have publicly announced intentions to use EPYC processors, including Microsoft Corporation (NASDAQ:MSFT), Baidu Inc (ADR) (NASDAQ:BIDU), and Tencent Holdings Ltd (OTCMKTS:TCEHY).

But here’s the kicker: things are about as good as they will get.

When you’re trading at more than 40 times next year’s earnings estimates, you need to have an accelerating growth story to support a higher share price. But AMD’s growth story isn’t accelerating anymore. Revenue growth next quarter is projected to be the same as this quarter, and that actually represents a significant sequential decline in revenues. Next year, revenue growth is expected to come down meaningfully.

The underlying growth narrative appears to be shifting. Whereas this market was once looked at as a two-horse race between AMD and NVDA, old titan INTC is now back in the fold. Intel recently launched its new line of Coffee Lake processors, and the sentiment around them is quite bullish.

Overall, this is creating a surge in competition in the CPU marketplace. These elevated competitive risks were not appropriately baked in the AMD stock price. The stock was priced for Advanced Micro Devices to not only continue to steal market share from INTC at a rapid rate, but also to start transforming into a formidable competitor to NVDA in certain high-end markets like cloud computing.

While AMD does have some wins with its EPYC processors, all signs point to NVDA maintaining dominance in key high-end markets. Meanwhile, all signs also point to INTC starting to win back some market share from AMD.

All in all, there is no reason this stock should trade at 40 times next year’s earnings estimate. There is simply too much competition and not enough growth to warrant that kind of multiple.

Bottom Line on AMD Stock

AMD stock is appropriately correcting downward as the market reprices the stock to more appropriately reflect elevated competitive risks.

I don’t think this correction is over.

Will AMD stock fall to $5? I don’t think so. But I also don’t think this stock will end 2017 in positive territory.

As of this writing, Luke Lango was long INTC, NVDA, and BIDU.

Article printed from InvestorPlace Media, https://investorplace.com/2017/10/advanced-micro-devices-inc-amd-stock-selloff/.

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