The S&P 500‘s top stock of 2019 was chip-maker Advanced Micro Devices (NASDAQ:AMD), with AMD stock up about 160% in the year. Impressively, AMD stock was also the S&P 500’s top stock of 2018, rising 80% in that year. Even more impressively, before turning into the S&P 500’s top stock in back-to-back years, AMD stock posted a jaw-dropping 300% return in 2016.
In other words, Advanced Micro Devices stock has been red-hot for several years now. From the start of 2016, shares are up nearly 1,600%, versus a 60% gain for the S&P 500.
What has driven the sustained out-performance in Advanced Micro Devices stock? Sustained market share expansion in the very big global semiconductor market. That is, a few years back, AMD was a no-name player in the Intel (NASDAQ:INTC) dominated computer processing unit (CPU) market. But over the past few years, AMD has made significant inroads against Intel, leveraging superior technology and quicker-to-market product times to expand its CPU market share significantly.
As AMD has gained market share, the company’s revenues, margins, and profits have all soared, as has the AMD stock price. It has gone from $3 at the start of 2016 to nearly $50 today. Can the big rally continue in 2020?
Yes. But at a much slower pace, and with much larger risks. Here’s a deeper look.
Advanced Micro Devices Stock Can Move Higher
My thesis on Advanced Micro Devices stock has been shockingly simple. So long as AMD keeps gaining share in the big CPU and GPU markets, AMD stock will keep moving higher.
Consider the following: Global semiconductor sales will measure about $410 billion in 2019 — and that’s a down year. In 2018, global semi sales were up above $450 billion. The big CPU and GPU players in this market — Nvidia (NASDAQ:NVDA) and Intel — have $150 billion-plus market caps. Advanced Micro Devices, meanwhile, has just a $50 billion market cap. But AMD is quickly stealing share from Nvidia and Intel. If this trend persists, then Advanced Micro Devices could realistically be on a pathway towards becoming a $100 billion or $150 billion-plus company one day.
It is this logic which has continued to support big gains in AMD stock over the past few years. Importantly, what drives adoption of this thinking is sustained market share expansion. Thus, so long as AMD keeps gaining market share and the company remains a fraction of the size of Intel and Nvidia, then Advanced Micro Devices stock will likely keep heading higher. That is exactly what will happen in 2020.
At present, Advanced Micro Devices is in full-swing when it comes to mass producing next-gen, 7-nanometer processors. Intel won’t release comparable 7-nanometer processors until the the fourth quarter of 2021. Thus, throughout 2020, AMD will be the only viable player in the market with such products, and this open field devoid of serious next-gen competition should propel continued share expansion and big revenue and profit growth.
Against that backdrop, it’s tough to see AMD stock not going higher.
Beware Valuation Risks At These Levels
Although Advanced Micro Devices will likely move higher in 2020, valuation friction will limit the magnitude of those gains.
I continue to see Advanced Micro Devices as an out-sized share gainer in the global semi market over the next several years. I also think that the pace of share expansion will slow in 2021 and after, as Intel introduces 7-nanometer products and levels the competitive playing field. As such, considering that the global semi market will likely grow sales at a historically normal low single-digit pace over the next few years, AMD realistically projects as a ~15% revenue grower into 2025.
Gross margins will improve with scale and as the company breaks into more valuable end-markets. Expense growth rates should moderate, too, which will lead to positive operating leverage.
Big picture: 15% revenue growth on top of steady margin expansion should drive 20%-plus profit growth at AMD for the next several years. But, even profit growth that big isn’t enough to fundamentally support much more upside in Advanced Micro Devices stock.
My best-case scenario pegs AMD’s 2025 earnings per share at $3.50. Based on an information technology sector-average 21-times forward earnings multiple and a 10% annual discount rate, that equates to a 2020 price target for AMD stock of $50. That’s roughly where shares trade hands today.
Sure, stocks that are firing on all cylinders can and often do trade above their fundamentally supported fair values. So, AMD stock will likely shoot above $50 in 2020. But buyers up there should beware of valuation risks.
Bottom Line on AMD Stock
Advanced Micro Devices stock has been the S&P 500’s best-performing stock for two years in a row. Shares will likely continue to move higher in 2020 thanks to continued market share expansion. But the valuation today makes it seem highly unlikely that AMD stock notches its third consecutive year as the S&P 500’s top performer in 2020.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
