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One Simple Reason to Buy Advanced Micro Devices Stock — And One Reason to Sell It

AMD's business is enormously attractive, but history suggests that the valuation of AMD stock may have gotten out of hand

The long-awaited breakout of the Advanced Micro Devices (NASDAQ:AMD) stock price has arrived. Starting in early October, Advanced Micro Devices stock gained over 45% in about six weeks. Even after a recent pullback, the shares sit just below a 13-year high.

One Simple Reason to Buy Advanced Micro Devices Stock — And One Reason to Sell
Source: Joseph GTK / Shutterstock.com

It’s a breakout that, to be honest, I missed. I’ve long argued that  Advanced Micro Devices stock would do well over the long-term, but  in September I worried that the stock lacked a near-term catalyst. As it turned out, the rally of the chip sector provided such a catalyst. The rally either benefited or was led by AMD, depending on one’s perspective.

The question, as always in the market, is what comes next. And there are solid arguments both to ride the wave of Advanced Micro Devices stock or seriously consider taking profits. Indeed, the debate over the AMD stock price echoes arguments about the market,and the sector, which both trade at all-time highs.

The Simple Case for AMD Stock

One comparison highlights the opportunity of AMD stock. Specifically, Advanced Micro Devices stock has a market capitalization of about $45 billion. Rival Intel (NASDAQ:INTC) is valued at over $250 billion.

Advanced Micro Devices isn’t going to pass Intel in market value any time soon. Intel still is dominant when it comes to providing computer processing units (CPUs)  for personal computers. It spent years developing  a microprocessor brand, which is a unique strategy for a chip maker. AMD has a roughly 5% share of the server market, and its share of the graphics processing market lags that of Nvidia (NASDAQ:NVDA) in GPUs.

All that said, AMD clearly is going after Intel, in particular, and the upstart is clearly winning. In the third quarter, Intel’s sales were flat year-over-year. Advanced Micro Devices revenue increased 9% YoY — but that modest increase is an outlier. In Q4, its sales should soar over 40%, with analysts, on average,  expecting 27% growth for AMD in 2020, versus  a 2% gain by Intel.

Whatever the precise numbers, AMD can clearly create value for shareholders as it takes market share from Intel. And there are two reasons why AMD’s market  share gains are likely to  continue.

First, AMD seems to be running on all cylinders. Leaked information on the company’s new 64-core Ryzen Threadripper 3990x chip drove a 2% bounce by AMD stock yesterday. The entire Ryzen line, as well as the company’s EPYC graphics processing units, set the company up well for future growth.

Second, Intel in particular is struggling. Its long-running development issues have led to significant product delays. Just last week, Intel apologized to its PC customers like Dell (NASDAQ:DELL) and HP (NYSE:HPQ) for CPU chip shortages.

Again, AMD won’t necessarily take all of Intel’s business. But the enormous valuation gap between the companies suggests that  AMD stock price can still climb tremendously as the company increases its market share.

The Big  Risk Facing  Advanced Micro Devices Stock

The main problem of Advanced Micro Devices stock is valuation. AMD stock is trading at over 35 times analysts’ average  2020 earnings per share estimate. That doesn’t necessarily feel like a huge multiple when growth stocks  often are valued at over 100 times their earnings  or remain unprofitable). But it’s a high number for AMD stock and for semiconductor stocks.

When a chip stock has that kind of multiple, trouble usually ensues. Last year, NVDA’s price-earnings multiple expanded from the mid-30s to above 40 by late summer. Of course, the stock tumbled 50% in Q4 as the bursting of the cryptocurrency bubble sent it and AMD stock price tumbling.

Advanced Micro Devices stock, too, has retreated sharply from its peak valuations — and not just during last year’s sector-wide selloff. As MarketWatch  columnist Beth Kindig noted, the forward multiple assigned to AMD stock  has reached all-time highs. The last two peaks came before the dot-com bust and the 2008 crash. Both times, AMD stock price tumbled quickly.

To be fair, it seems unlikely that history will repeat. For one, Advanced Micro Devices simply is a better company than it was last decade. And even in a market at all-time highs, there isn’t much likelihood of  a 2000-style or 2008-style crash.

That said, the valuation of Advanced Micro Devices stock is worrisome at this point, and it has been for awhile. The company’s Q3 earnings were not terribly impressive, as its performance was basically in-line with analysts’ average  expectations.

There are some echoes of past bull runs, when AMD stock, swept up in market rallies,  reached valuations that were potentially unsustainable. That doesn’t mean a crash is imminent, but it does make me wonder whether this run has gone too far.

The Epitome of the Market

Analysts are certainly questioning the valuation of AMD stock. Their average price target still sits below $35. Wall Street analysts haven’t always predicted the surges of Advanced Micro Devices stock, and several analysts did upgrade the shares after AMD’s earnings, but the stock’s valuation is a legitimate concern.

At the same time,  setting aside valuation for a moment, there seem to be few more attractive businesses in tech than AMD at the moment. The company has a clear opportunity to take share in a market that should grow, thanks to longer-term trends like Big Data and IoT (Internet of Things).

And so, Advanced Micro Devices stock really comes down to an argument between valuation and growth. That’s an argument that’s been going on in this market for much of the ten-year-plus bull run. So far, investors who have focused on growth have won out. Those who have worried about valuation have missed out. If that trend continues, the AMD stock price should continue to rise.

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


Article printed from InvestorPlace Media, https://investorplace.com/2019/11/one-simple-reason-advanced-micro-devices-stock-sell/.

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