Advanced Micro Devices (NASDAQ:AMD) has handled the market crash well. AMD stock slipped from $59 to $38 during the March crash. However, it’s now back up to $55. In fact, it’s right up against the $55 to $60 level that has served as resistance on several occasions. If AMD stock is able to power up through this range in coming days, it could trigger a big short squeeze.
While technicals look good for AMD, however, the fundamental picture is less clear. The company continues to report pretty good results. Revenues grew 40% this past quarter, for example, though a slowdown seems likely as consumer demand is trailing off thanks to the novel coronavirus. Additionally, AMD is struggling to convert these sales into further profits. The company’s price-earnings ratio is north of 100x, and it simply hasn’t developed the same unit economics as its larger rivals.
The Shifting Semiconductor Landscape
Last week, we witnessed a huge moment. The market capitalization of Nvidia (NASDAQ:NVDA) overtook that of Intel (NASDAQ:INTC). Nvidia is worth about $259 billion, while Intel comes in at about $247 billion. While that fact doesn’t affect AMD directly, it’s potentially a huge sentiment barometer for the tech landscape.
The old is out, the new is in. Intel earned $23 billion in net income last year. Nvidia generated just $3 billion in profits. Thus, while Intel is seven times as profitable as Nvidia, the market thinks Nvidia is worth more. The value of future growth prospects is exponentially higher than profits and dividends today; at least that’s what investors think right now.
With that in mind, investors might start to ask where AMD fits in among Nvidia and Intel. AMD is worth $68 billion, putting it around a quarter of both Nvidia and Intel in valuation. And AMD only earned $500 million in net income last year, which puts it well short of Nvidia let alone Intel.
AMD’s Financial Situation
Long-time readers may remember the inherent source of my AMD skepticism: The company has a far smaller research & development budget than both Intel and Nvidia. Over the past 12 months, Intel has spent a stunning $13 billion on R&D. Nvidia has used $3 billion on its research department. Meanwhile, AMD has used just $1.6 billion on R&D over the same span. In other words, for every dollar AMD spends on new product research, Intel spends nearly $10.
It’s not hard to guess who will generally have more advanced products for the market over the long haul, even if AMD has squeaked out a momentary edge.
Why doesn’t AMD spend more on R&D? For one thing, AMD’s finances remain shaky. The company is rated Baa2 at Moody’s and BB at S&P. These are both junk ratings. At S&P, for example, AMD would need a two-notch upgrade to make it into investment grade.
You might ask why AMD is a junk credit. It is profitable and on a winning streak, after all. However, semiconductors are a notorious boom/bust industry. AMD had a big surge in 2006, and another moderate comeback in 2011. Both times, however, the company found itself back on death’s door within a few years.
Structurally, AMD simply hasn’t been a great business. It’s now up to $7 billion in retained losses; that’s its cumulative negative profit since the company launched. In light of that, this year’s $500 million profit looks far from impressive. And AMD’s $3 billion of total liabilities loom large if and when AMD’s profits roll over again, as they often do.
AMD Stock Verdict
Ultimately, I remain an unbeliever in AMD’s story. Admittedly, there is the bullish case, namely that AMD becomes the next Nvidia-style semiconductor company that upends the existing order.
However, AMD has a ton to do to reach that point. For one, AMD is still primarily taking business from Intel. As discussed above, Intel trades at a low valuation – it’s currently at just 11x earnings. Logically, if AMD takes its profits out of Intel, it’s likely to earn a similarly-modest P/E ratio.
Nvidia has gone to the stratosphere on hopes of huge new revenue streams from emerging product categories such as autonomous driving. If Nvidia were just winning business from Intel and other established chip companies, the stock wouldn’t have gone so far. If AMD can reliably become profitable and hold market share in CPUs, it could be a decent business.
Historically, however, any time AMD has made gains, Intel has quickly overtaken AMD technologically and caused AMD’s shares to collapse again. In this case, AMD is now so expensive that it needs to not only hold off Intel in mainline chips, it also needs to carve out a share of new and emerging industries to justify its $68 billion valuation let alone trade up even more.
In this market, anything is possible. AMD stock could continue to rally as long as the narrative is strong. But be careful. There’s a huge gap between AMD’s actual revenues and profits today, and its stock price. And with AMD’s under-powered R&D budget, it’s not likely to be the big winner among the next generation of semiconductor products.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he owned INTC stock.