I wrote that Advanced Micro Devices (NASDAQ:AMD) was likely too pricey more than a month ago. At that time, AMD stock was at $52.05 per share.
On Friday, June 12, the stock closed only slightly higher at $53.50 per share. I think AMD stock is still too high at 35 times expected earnings for 2021. The most likely thing to occur is that earnings will rise and the stock will tread water.
That implies that over time AMD’s overall price-to-earnings ratio will tend to fall, rather than the stock price. In other words, you might not lose too much money, but the stock is not going to rise very much.
Comparing AMD Stock to Its Peers
For example, right now AMD stock trades for 52 times 2020 estimated earnings per share (EPS) and 35 times 2021 EPS. But Intel Corp (NASDAQ:INTC) trades for just 13.1 times 2020 EPS and 12.6 times for 2021. That is a wide gulf for two companies in the same semiconductor industry.
Moreover, Western Digital (NASDAQ:WDC) is at a ratio of just 7.2 times 2021 earnings. As well, Micron Technology (NASDAQ:MU) trades for just 10.5 times 2021 earnings, and Applied Materials (NASDAQ:AMAT) is at 13.3 times 2021 earnings. So on average, these four comparable stocks have a forward P/E ratio of just 10.9 times forward earnings.
Even if I add in Nvidia (NASDAQ:NVDA), at 36 times forward earnings, the sector average is still only 15.9 times 2021 earnings. That means that AMD’s 35 times ratio is more than 120% higher than the sector average.
What Is Going on With Advanced Micro Devices?
I pointed out in my last article that the free cash flow the company generates is not that great. In fact, in Q1 it was negative, but investors must be expecting that to turn around.
At the end of April, AMD provided a full-year forecast of 25% revenue growth. This was down from the prior guidance of 28 to 30%. The problem is that the recession leads to lower demand for notebooks, laptops, tablets, and other devices with AMD’s processors.
So far, the market seems to believe the company’s claims that its revenue growth will dip 25%, but not all analysts agree. For example, Seeking Alpha‘s poll of 36 analysts estimates that AMD’s revenue will rise only 15.9% to $8.4 billion.
Moreover, Barron’s wrote recently that the market worries that people without jobs won’t buy AMD’s processors. The point is that if demand stays low during the second half of 2020, the company may not make its revenue targets.
I am not so sure that there will continue to be a recession through the second half of 2020. However, unemployment is still high, although improving. That alone will tend to hold back its revenue growth. Barron’s also mentioned that capital spending on cloud computing could slow in the second half. That will also slow down its growth.
What To Do With AMD Stock
Some analysts are still very optimistic about AMD stock’s prospects. For example, one analyst at Seeking Alpha writes that AMD is “ready for takeoff.” He does not believe that things will be as “dire” as others expect in the second half.
But my problem is that AMD stock is already priced for perfection. At the high absolute P/E ratio it trades at, plus its high relative valuation, the stock cannot abide by any hiccups. If growth, demand, and earnings do not measure up the rest of the year to expectations, you can expect it to tread water.
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.