Shares of Advanced Micro Devices (NASDAQ:AMD) have certainly recovered strongly after a punishing drop. AMD stock is now nearing all-time highs once again after a blistering rally. Many analysts continue to debate whether the lows are in for the overall market and chipmakers in particular. A more pertinent question is whether stocks like AMD should be poised to break out to new highs given the effect the novel coronavirus crisis will have on future growth. In my opinion, the answer is a resounding no.
Advanced Micro is currently trading at by far the highest price-to-sales ratio in the past decade with a multiple approaching 10. Other valuation metrics, such as price-to-earnings and price-to-free cash flow, are also at historic extremes.
AMD stock is incredibly rich, even on a forward basis. The 2021 consensus is for $1.38 in earnings, equating to a 41 forward P/E. Expectations for 2022 are for $1.44 and a subsequent 39 multiple. At some point earnings do matter and valuations become meaningful, even in this momentum driven market. The stock has once again reached that point.
InvestorPlace Contributor Chris Lau took a deeper dive into valuations in a recent analysis. He noted that the company on March 2 saw little impact from the virus, although they did warn that revenues would be at the lower end of guidance. Mr. Lau went on to say that given the current projections, the fair value of AMD stock would be $51 per share, or roughly 10% below the $56.60 closing price of AMD.
Analysts generally concur on that fair value price target with analysts consensus of $53.70 according to TipRanks. This equates to over a 5% decrease from the $56.60 closing price of AMD stock. The highest 12-month target is $66 with the lowest checking in at $33 per share. Certainly not a resoundingly bullish outlook for AMD stock.
The stock is looking extremely overbought on a technical basis. Bollinger Band Percent B traded well above 100 before finally weakening. The MACD reached the loftiest levels of the year before it softened. Its 9-day RSI hit 75 before it too fell back. AMD stock is trading at the largest premium to the 20-day moving average over the past 12 months. The prior time all these indicators flashed red simultaneously marked a major top in AMD stock. There is also major overhead resistance at the $58 level.
Most importantly, AMD finally had a down day after a massive rally. Shares had rallied 33% over the past 8 trading days since making a low near $42 on April 3. Friday finally saw some push back as AMD opened higher, but quickly changed course to close lower on the day. This type of reversal pattern is many times indicative of a short-term top in the stock. The buyers have become exhausted and the sellers have taken control. It is even more powerful given the magnitude of the recent rally, which took place at a major resistance area.
Earnings are due April 28 after the market closes. Earnings are expected to come in at 19 cents a share on revenues of $1.78 billion. The last four quarters have seen AMD pretty much in line with analysts estimates, beating or missing by only a penny at most. More important, obviously, will be the forward guidance and updated coronavirus impact. Although the impact may be muted for AMD, there will be an impact nonetheless. Slowing revenue growth is almost a certainty. This makes the extreme current valuations even more obtuse.
How to Trade AMD Stock Now
Implied volatility (IV) is elevated in the May 1 expiration options since earnings are due during that week. So, to position for a pullback and take advantage of elevated IV a put diagonal spread makes probabilistic sense.
Key trade idea: Buy AMD May 15 $52.50 puts and sell AMD May 1 $52 puts for $1.00 net debit.
Maximum risk on the trade is $100 per spread. The trade structure captures a 10 point vol diffential by selling an 80 IV and buying a 70 IV. Ideally, AMD stock closes near $52 at May 1 expiration to realize the maximum potential gain. It also allows for additional selling of May 8 expiration puts to further hedge the position once the May 1 options expire.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at timbiggam@gmail.com.
