Advanced Micro Devices (NASDAQ:AMD) stock has provided investors with stellar returns of 154% in 2019. Even as AMD stock trades at a forward price to earnings ratio of 75.3, I believe that the rally is far from over.
Strong earnings growth and market share gain will continue to justify premium valuation and the positive trend will sustain. Therefore, AMD stock is worth holding through 2020.
Earnings growth for 2020 is expected at 75.8% and this backs my point on valuations. In addition, earnings are likely to grow at a CAGR of 24.2% over the next five years. This is attractive as compared to industry level earnings growth expectation of 14.8%.
Before I talk about company-specific growth triggers, I want to add a note on the competition. Intel Corporation (NASDAQ:INTC) is clearly lagging behind Advanced Micro Devices. While the latter will experience strong earnings growth in the next five years, Intel’s growth will be subdued. The company’s CFO expects strong revenue growth and margin expansion in 2023. Importantly, 10nm node will be delayed and that will benefit AMD.
AMD has already been surging ahead of Intel. Data from Mindfactory indicates that the AMD stock price upside is being driven by fundamental factors. Data from Mindfactory is limited to Germany, but if we look at the broad x86 processors market share, AMD has made meaningful inroads. The company’s market share has increased from 22.3% in 3Q17 to 31.2% in 3Q19. I believe that this positive trend is likely to sustain.
Gross Margin Expansion Will Continue
Advanced Micro Devices reported a gross margin of 40% for 3Q18. For 3Q19, gross margin expanded by 300 basis points to 43%. Further, AMD has guided for 44% gross margin in 4Q19.
Margin expansion is another key factor that will take the stock higher in 2020. Ryzen and EPYC processor sales have triggered margin expansion. As AMD continues to gain market share through Ryzen and EPYC, gross margin and cash flows will grow.
Importantly, EPYC processor sales will be robust in the coming years with cloud and 5G acting as growth triggers.
International Business Machines (NYSE:IBM) and Nokia (NYSE:NOK) are using AMD EPYC processors for their cloud and 5G customers. There are other big names that have already adopted AMD second generation EPYC processors.
Ryzen momentum will also sustain in 2020 with the launch of 7-nanometre accelerated processing unit. In addition, AMD also has 7nm mobile chips to be launched in 2020. With a strong pipeline of products, sales, gross margin and earnings will continue to improve.
To back my view on continued sales momentum, AMD CPUs have outperformed those of Intel-based CPUs on performance test. This gives an edge to AMD in 2020 and beyond. The partnership with Taiwan Semiconductor Manufacturing Company (NYSE:TSM) is likely to ensure that AMD maintains the advantage.
Trade Deal Supports AMD Stock Upside
AMD stock was range-bound for a large part of 2019. It was in October that the stock had a convincing break-out above $30.
The first reason for the sharp rally is growth in market share, margin expansion and robust sales from new launches.
The second key reason for the rally is the gradual progress in the trade deal between the United States and China. With phase one of the trade deal done, there are hopes that de-escalating tensions will boost GDP growth.
With AMD deriving 39% of 2018 sales from China (including Taiwan), the trade deal should have positive implications on earnings growth. Both the cloud and enterprise segment stand to benefit. Recently, Tencent (OTCMKTS:TCHEY) announced that it will use AMD’s EPYC processor in its internally-designed server. As the trade deal progresses, I expect more contracts from China to boost AMD’s growth.
My Final Views on AMD Stock
AMD stock does look expensive from a PE valuation perspective. However, with strong expected earnings growth for 2020 and beyond, the rally might sustain with intermediate corrections.
With more product launches in 2020, the markets will remain excited and there is no doubt that AMD has an edge over Intel.
AMD is also positioned for growth in free cash flows as gross margin expands. This will further improve the balance sheet as net debt declines.
Overall, AMD stock remains interesting for 2020 and any profit booking can be used to consider fresh exposure to the stock.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.
