Advanced Micro Devices (NASDAQ:AMD) stock now faces another critical test. After Advanced Micro Devices stock broke through its stubborn price ceiling, the owners of AMD stock must now contend with the issue of the company’s China business.
Given AMD’s potential profit growth, its current valuation may seem low.However, a breakdown of U.S.-China relations could destroy the bullish investment thesis on AMD stock. So though AMD may have somewhat priced in its current geopolitical challenges, investors need to be cautious about AMD stock.
Advanced Micro Devices Stock Is Not Expensive
AMD stock trades at a forward price-earnings (PE) ratio of just under 36. Analysts, on average, expect its earnings to increase 36%.49% per year over the next five years. That implies a price-to-earnings-to-growth (PEG) ratio of around one, indicating that AMD is worth buying.
However, in a column published last month, I stated that the near-term prospects of AMD stock would hinge on U.S.-China relations. As long as there is no signed trade agreement between the countries, I remain cautious on AMD’s China business. So investors must decide whether the PEG ratio of around one prices the China-related threats into Advanced Micro Devices stock.
I would argue that it does.
U.S.-China Relations Remain Tenuous
Optimism from the White House or proclamations that we’re “on the verge” of a deal mean nothing. Hope won’t do much for the top line of AMD. Moreover, even after the U.S. and China sign an agreement, it may have limited value, as time will tell whether the countries will actually honor the trade pact.
Furthermore, President Trump signed two bills backing the Hong Kong protesters. He did that over the objection of China’s President Xi. Moreover, President Trump still plans to impose a 15% tariff on $160 billion of Chinese goods beginning Sunday. Although we have some indications that these tariffs will be delayed, they add to the uncertainty facing Advanced Micro Devices stock.
Worst-Case Scenarios Do Not Appear Likely
Still, even if the reported agreement in principle between China and the U.S, falls through, I do not see a full-blown trade embargo between the U.S. and China as likely.
Both economies depend heavily on one another. In the semiconductor industry, AMD is hardly the only company that depends on China for revenue. Almost every major chip maker —Intel (NASDAQ:INTC), Nvidia (NASDAQ:NVDA), Qualcomm (NASDAQ:QCOM), and many others—all depend heavily on China.
Still, Goldman Sachs estimates that about 26% of AMD’s revenue comes from China. If that revenue falls sharply or disappears, most of the growth that AMD has achieved under the leadership of CEO Lisa Su would not be eliminated. However, the bullish investment thesis on Advanced Micro Devices stock would be torpedoed.
If AMD’s profit growth falls to average or below-average levels following difficulties with China, its forward P/E ratio of almost 39 would become high. Less than one year ago, the AMD stock price fell as low as $16.03 per share amid a sharp decline of tech stocks. A similar scenario could unfold again.
However, if trade relations improve, both AMD’s profit growth and Advanced Micro Devices stock could both move much higher. AMD stock price could face some resistance as it retests the dot-com bubble high of $48.50 per share. However, AMD’s low PEG ratio indicates it could rise above the $50 per share mark under the right conditions. Consequently investors who want to buy AMD stock can cautiously proceed.
The Bottom Line on Advanced Micro Devices Stock
Risk-averse investors can buy Advanced Micro Devices stock but should proceed carefully. AMD’s PEG ratio makes it looks like a bargain. As massive earnings growth continues under the leadership of Lisa Su, AMD’s forward PE of almost 39 seems justified.
However, the company also depends heavily on China. The outlook of the trade agreement appears uncertain, and the positive investment thesis on Advanced Micro Devices stock could be destroyed if U.S.-China trade relations deteriorate.
As things stand now, figuring out whether AMD stock will retest its 2018 lows or break through its dot-com-bubble high has become more difficult. However, at a PEG ratio of about one, taking a chance at this point could be worthwhile.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.