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A Great Business Alone Might Not Be Enough to Boost AMD Stock

AMD stock has earned its gains, but its valuation is questionable

There’s no argument that Advanced Micro Devices (NASDAQ:AMD) has executed a hugely impressive turnaround. Bear in mind that the AMD stock price was at $2 as recently as early 2016. Advanced Micro Devices stock has gained some 1,500% since then.

Source: Grzegorz Czapski / Shutterstock.com

The gains of late seem particularly impressive, given the sentiment toward semiconductor stocks at the moment. In the last year, AMD stock has risen 86%. Shares of graphics processing unit rival Nvidia (NASDAQ:NVDA) have dropped 46%. Intel (NASDAQ:INTC), which until recently dominated AMD in central processors, has seen its stock fall roughly 16% in that period.

The divergence in the performance of those three stocks isn’t necessarily a surprise. The reason AMD stock price has soared is because the company now is a real competitor to both Intel and Nvidia. But the question now, with AMD stock touching a 13-year high last week, is what comes next.

AMD’s Business Continues to Sizzle

As far as AMD’s business goes, the news is good and seemingly getting better every day. The company was formerly a low-cost alternative to Intel, and its products were mostly used in cheap computers. Its CPUs now can go head-to-head with Intel chips on performance. A recently announced partnership with Samsung moves AMD back into mobile and should generate high-margin licensing revenue for AMD to boot. AMD’s EPYC chip, as hoped, is driving wins in the key datacenter space against both Intel and Nvidia.

There’s really little debate left in terms of the success of AMD’s turnaround. Those who were skeptical about AMD stock have been converted. AMD is making some of the best CPU and GPU chips in the world. That’s not something that could be said five years ago or even three years ago.

Will AMD Stock Price Climb the “Wall of Worry?”

But AMD stock has soared over the last few years. And there are no shortage of analysts and investors who see the current price of AMD stock as potentially too high. Advanced Micro Devices stock actually sits almost 10% above the average Wall Street price target on AMD stock. On this site, I’ve worried about AMD’s valuation – and I haven’t been alone.

Meanwhile, sector headwinds and trade-war worries have pressured most other chip stocks. AMD’s chief rivals aren’t the only chip names that have been under pressure. Micron (NASDAQ:MU) again is flirting with a multi-year low. Lam Research (NASDAQ:LRCX) and, to a lesser extent, Applied Materials (NASDAQ:AMAT) have pulled back of late, and those semiconductor equipment manufacturers often are the proverbial canaries in the coal mine in terms of chip-sector demand.

The retort from bulls is simple: most AMD bears have been proven wrong over the past three-plus years. AMD stock price didn’t look particularly cheap last year, either. Yet it’s continued to rise, climbing the so-called ‘”wall of worry“.

The bulls have a point. In this market in particular, the quality of companies’ business has proven to be more important than the valuation of stocks. Seemingly expensive names can get more expensive if they deliver on their potential. AMD, at the moment, certainly has proven to be a quality business, and there are no shortage of reasons to believe it will deliver going forward.

Valuation Remains a Concern for Advanced Micro Devices Stock

All that said, it is increasingly difficult to make the fundamental case for AMD above $30. In the context of the tech market, a forward price-earnings multiple of 32 isn’t that steep. But for a chip maker, that’s extremely expensive, as the owners of NVDA stock learned last year.

Over the long haul, the chip sector remains cyclical, and the stocks of cyclical sectors usually trade at lower valuations than the market as a whole.  AMD is offsetting that cyclicality with its new products,  but it won’t be able to do so forever.

AMD’s margins can rise, and they certainly can expand at a faster rate than those of Intel. But looking even at enterprise value to revenue, AMD stock is pricing in quite a bit of improvement. Nvidia trades at about 7.6 times its sales, and its operating margins were near 40% last year. AMD’s margins might get above 10% next year, but it trades at about 5.5 times its revenue.

It’s exceedingly difficult to argue that AMD stock should trade at the same valuation as NVDA, given the enormous gap in their margins that likely will continue going forward. Yet AMD’s valuation already is close to that of NVDA.  Moreover, analysts, on average,  only expect  a 6% increase in AMD’s sales this year, although they expect its revenue growth to accelerate to 20%+ next year.

It’s hard to look at AMD’s fundamentals and argue that its potential isn’t priced into AMD stock, at least to some extent. The market clearly has caught on to the story, and analysts, on average, project solid growth going forward. But that growth is reflected in Advanced Micro Devices stock already.

But that doesn’t mean AMD stock should be shorted or even necessarily that it needs to be sold. But we’ve seen Advanced Micro Devices stock, even during this long rally, tumble hard and fast a few times. Given AMD’s recent run, and the pressures on the sector, I wouldn’t be surprised to see those types of pullbacks occur again,  since everything but perfection looks priced into AMD stock. We’ll see if AMD can deliver on investors’ new, much higher, expectations.

As of this writing, Vince Martin has no positions in any securities mentioned.

 

 


Article printed from InvestorPlace Media, https://investorplace.com/2019/06/good-business-alone-enough-boost-amd-stock-price/.

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