AMD Stock Is a Winner, but It Is Clearly Overvalued Here

Advanced Micro Devices (NASDAQ:AMD) is one of the few winners for 2020. Not only is AMD stock in positive territory, up about 8% for the year, but it is also up more than 75% year-over-year. That is truly rare for today’s stock market.

AMD Stock Is a Winner. but It Is Clearly Overvalued Here

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But is it too much? The stock looks clearly overvalued at this point. For example, its forward price-to-earnings ratio is an astounding 48.3 times earnings.

This is the case of a very profitable company in a sea of struggling unprofitable companies, but the market charges a huge premium to participate in those earnings. For example, AMD reported Q1 revenue up 40% and non-GAAP earnings of $222 million, up 258% from a year ago. This is clearly one of the few companies in the U.S. showing that kind of growth.

But comparing its annualized run-rate earnings going forward shows just how much the market charges for an investor to own a portion of those earnings. The run-rate going forward is $888 million, with no adjustment higher for the Christmas season.

Since AMD stock has a market value of $58.42 billion, that implies the run-rate price-to-earnings ratio is 263 times. Even if we doubled the run-rate of earnings to $1.776 billion, a massive projection, the forward P/E ratio is still 33 times earnings.

That implies you would have to wait 33 years for your investment to break even if AMD paid out 100% of its earnings each year to its shareholders. That is an extraordinarily high price to pay for a successful company.

AMD Stock Is Too Expensive

Another reason why I think AMD stock is overblown is that in Q1 2020, the company actually made negative free cash flow. In other words, it was burning cash. Advanced Micro has had negative free cash flow in two of the last four quarters.

For example, its cash flow from operations in Q1 was negative $65 million, according to the company’s recent 10-Q filing with the SEC. When you add in capital expenditures of $55 million, its free cash flow for the quarter was negative $120 million. So much for all the non-GAAP profits.

This means that AMD burned through $120 million of cash during the quarter, despite running a profitable operation. That is what analysts call negative conversion. The company’s profits did not convert into cash piling up.

However, over the past year, the company made just $432 million in free cash flow profits. This was despite generating revenue over the past year of $7.245 billion. This is a small FCF margin of just 6%.

So why is the stock selling for 135 times its FCF generated over the past year (i.e., $58.42 billion divided by $432 million)? In fact, even if FCF triples over the next several years, the stock will still be expensive at 45 times FCF.

The point is if AMD is so profitable, why doesn’t the cash it generates grow very much? For example, the company’s net cash and investment balance (after all debts) is only $897 million.

But over the last five quarters, AMD has raised equity capital of $526 million. Why did the company need to raise equity if is so profitable? Net cash only grew by $371 million. Doesn’t that seem a very small amount for a company with a market value of $58.4 billion?

What Is Really Going on With AMD Stock?

The market seems to be desperate to get behind any kind of company that shows consistently growing profits. This is even though Advanced Micro recently posted negative FCF numbers. The problem is this leads to higher and higher value metrics for the stock.

Moreover, AMD stock market investors do not even receive a dividend. Granted, the company has been using its free cash flow and its equity rise form last year to pay down debt. That is a noble use of those sources of capital.

Advanced Micro Devices had $1.07 billion of debt on its balance sheet. Now it has just $488 million. It used FCF and the equity raise during Q1 2019 to pay down this debt. This helps the company to make more profits in the future by not having to pay interest expenses.

But it still gets down to this: the valuation for AMD stock is too high for a company that trades for 48 times forward earnings. It is not worth the 135 times historical FCF generated over the last year and even 45 times if FCF were to triple somehow over the next several years.

As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide, which you can review here.

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