Valuation Becomes an Issue for AMD Stock Above $25

AMD stock is killing it again in 2019, but the valuation of AMD is starting to become a concern

Shares of Advanced Micro Devices (NASDAQ:AMD) have been on a tear in early 2019 after the long- term bull thesis on AMD stock has gained clarity and credence amid a flurry of positive developments. Year-to-date, AMD stock is up 37%, versus an 11% gain for the S&P 500 over the same stretch.

Why AMD Stock Is Stuck in Neutral for Now
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In early 2019, there were five reasons to become bullish on AMD stock. All five of those reasons remain alive and well today. Specifically, as evidenced by a recently announced major partnership between Alphabet (NASDAQ:GOOG)  and AMD for GOOG’s cloud gaming platform, Google Stadia, AMD continues to gain share in the CPU and GPU markets.

So AMD is a small company whose share of some very big markets is increasing, adding to the allure of AMD as a takeover target. And, with those market expansion tailwinds only growing, the company’s earnings per share can rise to $2 within the next several years.

All in all, the big picture, long-term bull thesis supporting AMD stock remains as healthy as ever.

Having said that, valuation matters, and the valuation of AMD stock is challenged above $25. Long story short, while $2 of EPS is achievable for AMD, it probably won’t reach that milestone soon enough to warrant AMD stock trading at or above $25 before the end of fiscal 2019. Even in a best-case scenario, a reasonable fiscal 2019 price target for Advanced Micro Devices stock is just $27.

Thus, above $25, AMD stock may be able to grind higher, but the risks posed by AMD are rising, too, and that’s reason enough to push me into the profit-taking column.

AMD’s Fundamentals Are Strong

There is nothing with the long-term fundamental growth outlook of AMD.

AMD is a relatively small company (the market cap of Advanced Micro Devices stock is below $30 billion) which is attacking the very large global CPU and GPU markets and rapidly gaining share in those markets. This narrative was most recently reinforced by Alphabet – one of the world’s largest tech companies – choosing AMD’s custom graphics processing units (GPUs) for its massive cloud-gaming operation, Google Stadia.

Clearly, AMD is becoming more and more trusted by bigger and bigger players in both the CPU and GPU markets. Consequently, the company’s share of those markets is rapidly climbing. Moreover, those markets are supported by non-cyclical growth drivers, such as the expansion of data and AI.

In other words, AMD’s share of rapidly growing markets is rising. Furthermore, AMD is expanding into higher value segments of those markets, so its margins are ramping higher, too.

All in all, AMD is a big grower with big margin upside potential. As long as that remains true, AMD stock will be supported by a robust, long-term profit growth narrative, the likes of which will keep AMD stock on a longer-term uptrend.

AMD Stock Is Simply Overpriced

At today’s prices, however, the near-to-medium term outlook of AMD stock is less rosy.

Its earnings this year are expected to be 66 cents per share. With Advanced Micro Devices stock trading around $25, that implies a forward price-earnings multiple of nearly 38. That’s too rich.

Realistically speaking, AMD’s top line is poised to rise by high-single digit percentage levels, while its margins  are well-positioned to significantly increase over the next several years. That won’t lead to much more than 20% annualized EPS growth. More likely,the company’s EPS will increase by about 15% per year.

Assuming EPS grows at an aggressive rate of roughly 20% from fiscal 2021’s projected EPS base of $1.11, that means AMD won’t hit $2 EPS until fiscal 2024 at the earliest. Based on a forward price-earnings multiple of 20, which is average for growth stocks, that equates to a fiscal 2023 price target for AMD stock of $40. Discounted back by 10% per year, that implies a reasonable fiscal 2019 price target for AMD stock of roughly $27.

It’s more likely, however, that the company’s EPS won’t reach $2 until fiscal 2025, implying mid-teens profit growth between 2021 and 2025. Using the same assumptions as previously, that equates to a fiscal 2019 price target for AMD stock of just under $25.

So with Advanced Micro Devices stock trading north of $25 just a few months into 2019, it’s reasonable to label the stock as slightly overvalued in the near-to-medium term.

The Bottom Line on AMD Stock

AMD stock is supported by a great long-term growth outlook. The stock is just slightly out over its skis now in terms of its near-to-medium-term valuation. As a result, I’m taking some profits on AMD stock, but will look to re-enter the name on any big dips.

As of this writing, Luke Lango was long GOOG. 

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