Advanced Micro Devices (NASDAQ:AMD) is a very popular chip company, especially with gamers. But AMD stock has essentially gone nowhere in the past six months, just as I predicted in my last several articles.
For example, on May 5, AMD stock was at $52.19 when I wrote that it was overvalued. Now it’s at $53.40.
Also, on June 16, I wrote that AMD stock was done with big gains. It was trading for $54.46 then.
I project the stock will continue to tread water since it is so highly valued. In effect, the high growth rate in revenue and earnings is going to have to catch up with the high price-earnings ratio.
One Bright Spot: AMD’s Growth and Cash Flow
The company made positive free cash flow in 2019 of $176 million. This was the first time it did so in the past five years. Moreover, in the trailing 12 months (TTM) to March 2020, AMD made $231 million in free cash flow.
Moreover, its sales are expected to grow significantly in 2020 and 2021. Sales rose $3.9% in 2019 to $6.73 billion. But analysts expect 2020 sales to rise 24.8% to $8.4 billion and another 20.8% in 2021 to $10.15 billion.
That should significantly boost its free cash flow in 2020 and 2021. For example, at the same ratio of FCF to sales in 2019 (2.6%), 2020 should show $220 million, and $265 million in 2021.
In addition, I suspect that as sales grow, the FCF margin also picks up. For example, I would not be surprised to see $400 to $500 million in FCF by 2021.
This is obviously one reason why analysts are ebullient on AMD stock. They believe that the company’s rising sales, earnings, and cash flow will push up the stock even higher.
Valuation Is Catching Up With Growth
AMD’s Ryzen processors are popular, especially when combined with its Radeon GPUs (gaming processing units). And this has translated into sales and earnings growth.
Analysts polled by Seeking Alpha believe that the company will make $1.03 per share in earnings in 2020. They expect almost a 50% increase in profits in 2021 to $1.53.
MarketWatch‘s compilation of 35 analysts shows earnings going from $1.02 in 2020 to $1.50 in 2021. This is very similar to Seeking Alpha’s poll. In other words, analysts are very bullish on the company.
But this still means that the stock trades for 50.8 times 2020 earnings and 34.2 times 2021 earnings. These are very high valuation ratios. You get what you pay for.
Warren Buffett put it more succinctly: “You pay a high price for a cheery consensus.”
Therefore, I suspect that the most likely forecast is that AMD’s earnings will rise while the stock stays flat to slightly higher. This will have the effect over time of lowering the effective price-earnings ratio for the stock.
What to Do With AMD Stock
One Internet analyst, Simranpal Singh, does a very good job of analyzing the company and its valuation. I recommend if you are looking into buying AMD stock, you watch his video first.
He analyzes all the good news on AMD stock, including its popularity with users and gamers. This includes his analysis of the company’s history and its valuation.
For example, according to Singh, analysts believe the company is worth $58 per share on average. That is higher than today’s price.
And why not? After all, AMD stock has done quite well over the past four years, rising over 400% or so. But will AMD stock really continue going up given its high valuation?
In the end, Singh agrees that AMD stock is likely to tread water, and possibly even fall. I do not believe AMD stock will fall. But the point is that the stock seems to be fully valued at today’s price.
Another problem with the valuation is that there is no margin of safety. For example, there really is no bargain element in the purchase price, in terms of its valuation. Investors at this price have all the risk that growth does not occur as expected. In that event, the stock could easily deflate as expectations fall.
Buyer beware with AMD stock. Growth is exciting, but it apparently comes at a high price.
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.