Since 2016, investors in Advanced Micro Devices (NASDAQ:AMD) stock have been singing a happy tune. Year-to-date, the Santa Clara-based chip designer is up about 73%. In comparison, the iShares PHLX Semiconductor ETF (NASDAQ:SOXX) is up 28%. However, investors are now wondering if the inverted yield curve and China worries may affect the AMD share price adversely in the final quarter of the year.
In the long term, I believe AMD stock price is going to rise much more. Nonetheless, in the short term, there will likely be headwinds that investors should not necessarily overlook. Thus, I would encourage long-term investors to wait several weeks before buying AMD stock or hedge their positions if they currently own the stock.
The Trade War Is a Worry for AMD Stock
The U.S.-China trade war is now in its second year. Wall Street is nervous that the prolonged tariff wars will continue to affect chip companies’ earnings for the rest of the year. China is the leading consumer of semiconductors, responsible for more than 50% of the global demand.
And U.S. chip companies, including Advanced Micro Devices, lead the world with a combined global market share of nearly 50%. Furthermore, many technology companies, including AMD, either have manufacturing plants or joint ventures in China. Additionally, they typically use Chinese companies in their supply chains. Therefore, investors fear that American chip makers will be among the largest losers of the current trade war.
During the recent second-quarter earnings release on July 30, AMD management highlighted China as a risk. At present, over 30% of revenues come from China.
The chip industry is a highly cyclical one. In case of an economic slowdown either in the U.S. or globally, AMD stock and other industry players that fight for market share would be adversely affected. Earlier in August, U.S. and global equity markets went into a tailspin when the U.S. Treasury yield curve briefly inverted as short-term yields traded above those of the long-term variety.
We will not know when the next recession has started until we are in it, but we know investors’ sentiment can change rather quickly.
What’s Behind AMD Stock’s Latest Earnings?
In 2019, the chip company launched a robust range of products which Wall Street and AMD customers like. Yet Advanced Micro Devices has a history of reporting mixed results. When AMD released earnings on July 30, it was a similar story as it cut its full-year guidance.
In the earnings report, Wall Street paid attention to two segments: Computing and Graphics and Enterprise, Embedded and Semi-Custom.
Advanced Micro Devices stock reported earnings that met expectations amid tariff constraints. The group’s net income was $35 million, or 3 cents a share, compared with $116 million, or 11 cents a share, in the year-ago period.
The Computing and Graphics segment revenue was $940 million, down 13% year-over-year and up 13% quarter-over-quarter. Computing and Graphics revenue was lower year-over-year primarily due to lower graphics channel sales. The quarter-over-quarter increase was primarily due to higher GPU sales.
Enterprise, Embedded and Semi-Custom segment revenue was $591 million, down 12% year-over-year and up 34 percent sequentially. The year-over-year revenue decrease was primarily due to lower semi-custom product revenue. The quarterly increase was driven by higher semi-custom and EPYC processor revenue.
Overall many analysts saw the Q2 earnings report as a sign that AMD is executing its strategic plans well. Since late 2014, under the leadership of CEO Lisa Su, revenue has increased and the company has been improving its balance sheet. Its debt has also reduced considerably. Over the next five years, analysts expect AMD to grow earnings by about 30% annually.
What Could Derail AMD Stock?
AMD’s Q3 revenue outlook, however, fell below the Wall Street consensus because of weaker-than-expected console sales. The chip maker’s Q3 revenue outlook of $1.75 billion to $1.85 billion was lower than the forecast sales of $1.94 billion.
The company said revenue would likely be lower in both its computing and graphics and enterprise, embedded and semi-custom segments. Constantly lacking the “wow” factor in most of their earnings makes the AMD stock price vulnerable to rapid declines. Naturally, this has unnerved many long-term investors. And the markets penalized Advanced Micro Devices stock the day following the earnings release.
Wall Street has recently been debating whether chip stocks have reached their 2019 highs in the eyes of investors. For long-term investors, such gyrations in the sector are nothing new. However, it may mean more volatility for Advanced Micro Devices stock in the near term.
In the coming weeks, if any chip company issues a trading update that may include a potential weak guidance, then investors could easily become bearish on semiconductor stocks, including AMD.
Furthermore, analysts are debating whether Advanced Micro Devices stock is becoming overvalued. For example, its trailing price-to-earnings-growth ratio is about 3.5x. Similarly, AMD stocks’s price-to-sales ratio of about 5.6x is also quite high. To put the metric into perspective, the S&P 500’s average P/S ratio is 2.1x.
In summary, in the final months of the year, there are multiple pieces to the jigsaw puzzle that could affect the the stock price of Advanced Micro Devices.
Current AMD Stock Price
Wall Street loves turnaround stories. Over the past several years, AMD stock price has gone from $2 in early 2016 to an all-time high of $35.55 on Aug. 9, 2019. Within the past 12 months, the AMD share price is up about 20%.
If you are an investor who follows technical charts, AMD stock has strong resistance around $35, a level which it has not been able to pass four times in the past two months. In other words, if and when AMD stock can go and stay over $35, long-term investors should expect another big move up in the share price.
However, in the coming weeks, AMD stock is likely to trade within a range of about $27.5-$32.5. If there is a broad market decline, possibly similar to what we have experienced at the end of 2018, AMD stock price can easily move toward $25.
Finally, at this point, 12.3% of AMD’s shares are shorted. So while there are plenty of traders who have shorted AMD stock, not enough shares of Advanced Micro Devices are being shorted to set the stage for a massive short-squeeze rally. On the contrary, the current level of short selling in AMD stock may be enough to put further selling pressure on the shares.
Because AMD is a momentum leader stock, investors should expect sizeable daily swings in the stock price. Technically AMD stock is known to make a series of rallies and consolidations. We can expect this trend to continue in September, too.
The Bottom Line on AMD Stock
I am upbeat on the long-term outlook of AMD stock. Its data center GPU business is likely to gain further momentum in the coming quarters. Also as Microsoft (NASDAQ:MSFT) and Sony (NYSE:SNE) get ready to launch new gaming consoles that run on AMD chips, long-term investors will get get interested in AMD shares again. However, China trade issues can adversely affect next quarter’s numbers even more than initially expected.
If you already own Advanced Micro Devices stock, you might want to stay the course and hold onto your position. That said, if you are worried about short-term profit taking, then within the parameters of your portfolio allocation and risk/return profile, you may consider placing a stop loss at about 3%-5% below the current price point. This strategy books the paper profits you have already made from AMD stock.
If you are an experienced investor in the options market, you may also consider using a Sept 20 expiry at-the-money covered call strategy. In that case, you may for example buy 100 shares of AMD at a limit price of $30 and sell an AMD Sept 20 $30 call option, which currently trades at $1.65.
The $30 option offers some downside protection in case of volatility and a decline of the AMD stock price. It would also enable investors to participate in a potential up move. This call option would stop trading on Sept 20 and expire on Sept 21.
I find AMD stock to be a buy candidate, especially as its price dips below $30. In a few years, I’d expect the shares to reach $40.
As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.
