Back in September, I wrote about all things I liked about Advanced Micro Devices (NASDAQ:AMD). At the time, I advised investors to wait for a pullback to buy due to the stock’s lofty valuation. Unfortunately, AMD stock is up over 51% since that time. That’s right — not even the coronavirus outbreak can get AMD down.
It appears as if this is the best opportunity investors are going to have to get into AMD stock. Here are the pros and cons of buying now.
AMD stock has exposure to some of the strongest secular growth trends in the tech sector. It’s latest-generation Ryzen, EPYC and Radeon processors have performed strongly in the market. The company recently guided for roughly 20% compound annual growth rate (CAGR) in its PC/gaming segment in the long term.
Management expects double the CAGR in its data center segment, which currently accounts for about 15% of overall revenue. Management also said it expects to exceed 50% gross margins over time and expand its total addressable market to $79 billion by fiscal 2023.
“We view it as the only company that can challenge two large incumbents INTC and NVDA in a $50bn+ addressable market opportunity in PC, server, high-end gaming, deep learning and related markets where AMD has less than 10% value share currently,” Arya stated in December of 2018.
In addition to the longer-term growth opportunities for AMD, the stock has a major near-term catalyst coming in the second half of 2020. Microsoft (NASDAQ:MSFT) and Sony (NYSE:SNE) are expected to release their next-generation gaming consoles in time for holiday shopping season. AMD is the direct winner from the rollout of the Xbox Series X and the PlayStation 5.
“While both rely on a processor co-designed with AMD, the substantially improved graphics and adoption of ray tracing is likely to raise the bar for content creators and benefit the entire gaming/PC ecosystem,” Arya says.
There are two primary concerns with buying AMD stock at this point. First, it’s always risky to assume David can steal market share from Goliath. As Morningstar analyst Abhinav Davuluri says, Intel and Nvidia are not going to simply sit back and allow AMD to take their business.
“Intel’s 10-nm Ice Lake server CPUs (we view Intel’s 10-nm as comparable with TSMC’s 7-nm process) are slated to ramp throughout this year, while we believe Nvidia will launch 7-nm GPUs sometime this year, which we believe will collectively limit AMD’s momentum beyond 2020,” Davuluri says.
While I do believe competition is a major headwind for AMD, the other con is my primary concern. AMD stock trades at 29.4 times forward earnings. That valuation is a slight premium to Nvidia at 27.7 and a huge premium to Intel at 11.1. Davuluri projects CAGR of 13% through 2024.
That projection would be a solid growth trajectory, but it’s not necessarily enough to justify a valuation much higher than AMD’s current one. In fact, Davuluri says AMD stock deserves to trade much closer to Intel’s valuation. His fair value estimate based on a normalized earnings multiple of 17 is only $19.
How to Play AMD Stock
I still see AMD stock as the textbook high-risk, high-reward stock. The risk stems from the stock’s valuation and rising competition. The upside comes from its potential to steal market share away from Intel and Nvidia.
I love the idea of the console/gaming upgrade cycle being a bullish catalyst for AMD’s business. But at a forward earnings multiple near 30, I’d say much of that upside is already priced into the stock.
Given the fact that the COVID-19 outbreak barely moved AMD stock, I’d say it’s unlikely the stock has much near-term downside. But the fact that it’s up over 212% in the past three years suggests much of the potential bull thesis is already priced into the stock.
AMD is a decent long-term play. But the recent market selloff has created plenty of better buying opportunities elsewhere.
Wayne Duggan has been a U.S. News & World Report Investing contributor since 2016 and is a staff writer at Benzinga, where he has written more than 7,000 articles. Mr. Duggan is the author of the book “Beating Wall Street With Common Sense,” which focuses on investing psychology and practical strategies to outperform the stock market. As of this writing, Wayne Duggan does not hold a position in any of the aforementioned securities.