Shares of Advanced Micro Devices (NASDAQ:AMD) broke out of a long period of consolidation in a major way. AMD stock exploded higher in the month of July following bullish earnings and production woes from major competitor Intel (NASDAQ:INTC).
While certainly some of the recent red-hot rally was warranted, the monster move has come too far, too fast. Time for AMD to consolidate over the coming weeks.
The Valuation View
InvestorPlace Markets Analyst Luke Lango did an excellent analysis on AMD’s earnings report from July 30. I concur with the longer-term bullish thesis for AMD along with the short-term valuation frictions he mentioned.
AMD reported earnings on July 28 with EPS falling short of expectations at 13 cents per share versus consensus of 16 cents. Revenues beat at $1.93 billion compared to the $1.86 billion expected by analysts. The company did up guidance and now looks for 2020 revenue growth of 32% versus prior guidance of 25%.
Certainly AMD stock will benefit at the expense of Intel, as Lango mentioned, and growth rates will expand in the short term. The expectations, though, have now reached an extreme from a fundamental perspective. The price to sales (P/S) ratio now stands at almost 12 and at the richest multiple in the past 13 years. It is also higher than 89% of the 705 companies in the semiconductor industry, according to Gurufocus.
To put it in a different context, AMD stock is up 70% on the year while sales growth is expected to be up 32% in 2020. This means the P/S ratio has more than doubled in that time frame. It also means that further multiple expansion and stock gains will be difficult given the historically rich valuations.
AMD stock is undoubtedly getting overbought from a technical perspective. The 9-day RSI passed the 80 level before weakening slightly. The previous time this happened marked a significant short-term top in AMD. Both momentum and MACD are at by far the most extreme readings on the past year. AMD stock is trading at a massive premium to the 50-day moving average — another sign of euphoria.
Most importantly, AMD finally had a reversal day Friday. Shares opened higher and at fresh all-time highs before pivoting to close lower on the day. This type of price action is many times a sign the buyers have become exhausted and the sellers are in control. It is an even more powerful signal given that it took place at all-time highs and following such a monster rally.
Advanced Micro is also overextended on a comparative basis. The chart at right shows the relative performance of AMD stock to the VanEck Semiconductor ETF (NASDAQ:SMH).
Normally AMD and SMH tend to be fairly well-correlated. This makes sense since Advanced Micro has the fourth largest weighting in the ETF. Lately, however, that correlation has broken down considerably. SMH stock is up 50% from the mid- March Covid crisis lows while AMD stock is up nearly 85%. I expect that relative out-performance to begin to revert with Advanced Micro being a relative under-performer over the coming weeks.
I had a bullish viewpoint in my previous analysis on AMD from July 1. Shares were looking much better from both a technical and comparative perspective a month ago. Now that AMD stock has moved higher by 50% in July, my bullish outlook has turned somewhat bearish-because price ultimately does matter.
So to position for the red-hot rally in an overbought and overvalued AMD stock to slow down, an out-of-the money bear call spread makes probabilistic sense.
The AMD Stock Trade Idea
Sell the AMD Sep $90/$95 call spread for a 70-cent net credit.
Maximum gain on the trade is $70 per spread with maximum risk of $430 per spread. Return on risk is 16.27% or 182% annualized. The short $90 strike provides a 16% upside cushion to the $77.43 closing price of AMD stock.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a weekly option and volatility newsletter can visit the Options and Volatility Newsletter website.