The thesis sounds reasonable enough, on the surface. Advanced Micro Devices (NASDAQ:AMD) is in the midst of a turnaround that’s put rivals Intel (NASDAQ:INTC) and Nvidia (NASDAQ:NVDA) on their heels. Therefore, buy AMD stock to plug into the rebirth.
Now more than three years — and more than 1,500% — into the turnaround though, it may be time to accept a certain reality. That is, Advanced Micro Devices stock may already reflect the full potential of what’s to come.
It’s not an idea that will prove popular in many circles. The company, and its stock, has more than its fair share of cheerleaders. Many of them are quite vocal.
Just run through the number crunching before coming to an unwavering conclusion.
The Turnaround is for Real, but …
The underlying story has been nothing short of incredible.
CEO Lisa Su, who took the helm in 2014, wasn’t your typical management executive. She’s a techie, first and foremost, earning a PhD in electrical engineering from MIT, and spending most of her career in the engineering and development sliver of the industry.
It was just the kind of shake-up the struggling company needed at a time it needed it most. Su has led a sweeping overhaul of the company’s product lineup, ultimately driving the AMD stock price from under $2 in early 2016 to more than $30 right now. She’s also pushed the company out of the red and back into the black.
The next three years may or may not look like the past three years though.
Barring a global economic catastrophe, Advanced Micro Devices will continue to grow. Next year’s projected 24% sales growth, in fact, seems perfectly reasonable … even impressive.
There’s a context that takes some of the shine off that outlook though. That is, this year’s revenue growth is only on pace to improve a little less than 5%.
The bar is set low moving into next year.
Perhaps more concerning, 2021’s top line is only projected to improve to the tune of a more-modest 13%. That’s when Intel is expected to finally launch its first 7-nanometer chips, and presumably other updated hardware that will compare nicely with AMD’s tech.
That revenue growth will drive even-stronger profit growth, to give credit where it’s due. This year’s estimated earnings of 63 cents per share of AMD stock should swell to $1.06 in 2020, and then grow to $1.29 the year after that. But, those numbers still leave behind a significant valuation challenge.
AMD Stock has a Valuation Problem
Admittedly, it’s tough to look past the math when the underlying story is so compelling. Nothing lasts forever though, particularly when the trajectory of a stock’s rally is considerably sharper than the trajectory of that company’s results.
Said in simpler terms, Advanced Micro Devices stock has continued to rise when it arguably shouldn’t have.
Even pushing the analysis out to 2021’s expected revenue of $9.5 billion and earnings of $1.29 per share, AMD stock is trading at a forward price/sales ratio of 3.6x, and a forward price/earnings ratio of 24.4x. And again, that’s two years down the road. Those valuation measures are rich for most other tech stocks using expectations just one year ahead.
For perspective, NVDA stock is priced at 24.0 times next year’s earnings estimates, while INTC stock is valued at 10.6 times 2020’s projected income. Intel shares are also only priced at three times next year’s expected revenue.
Bottom Line on Advanced Micro Devices Stock
It’s not that nobody sees the looming headwind facing Advanced Micro Devices stock. Analysts see it quite clearly.
Although meteoric rallies would often induce the professionals to up their price targets and catch the next leg of a persistent advance, they’re decidedly not doing so in this case. The current consensus target of $33.18 is only 5% better than the current AMD stock price near $31.50. That’s a 12-month target too, and not a current valuation measure.
As Piper Jaffrey’s Harsh Kumar said, “Given the stock’s recent appreciation … and the current macro/geopolitical environment, we see the stock as more or less fully valued.”
It’s investors who are choosing not to see the fact that the bulk of AMD’s turnaround is already priced in. And in this case, it’s these individual investors in charge of setting the market price. They’re still basing it on the past rather than the plausible future.
Bottom line? Just be careful. This game of musical chairs could be ending soon, leaving some unsuspecting traders without a seat.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can learn more about him at his website jamesbrumley.com, or follow him on Twitter, at @jbrumley.
