AMD Can’t Sustain Its Stratospheric Valuation

Advanced Micro Devices (NASDAQ:AMD) is at such a high price-earnings valuation it is now at over 69 times earnings for 2020 and 46 times for 2021. This stratospheric valuation for AMD stock is not sustainable.

AMD Stock May Look Weak, but There' Still Lots of Opportunity
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In fact, the stock has been falling with the general market downturn in the past week or so. I suspect that it will continue until the stock gets into a buyable range.

By the way, it is not as though the company isn’t growing. The main reason its P/E falls next year is that earnings per share are expected to grow from $1.10 estimated for 2020 to $1.64 in 2021. This is based on the average of 36 analysts polled by Seeking Alpha. That represents a high 49% growth in EPS for next year.

But the point is that having a 69 earnings multiple implies that a company’s growth will be very high for a good long time. In effect, the high growth rate in revenue and earnings is going to have to catch up with the high price-earnings ratio.

Growth Drivers for Advanced Micro Devices

Analysts now expect sales to rise to $8.9 billion in 2020. This is up over 9% from $8.14 billion from just two months ago when I last wrote about AMD stock. Moreover, these same analysts now expect 2021 sales to increase by 22% to $10.87 billion. This is also higher than estimates just two months ago.

Barron’s has written extensively about why AMD stock is up over 66% so far this year, and over 156% in the past year. They believe that AMD is taking large portions of semiconductor chip market share away from Intel (NASDAQ:INTC), its main competitor.

This is mainly because Intel has failed to perfect its 7 nano-meter chip production process. However, AMD’s production partner, Taiwan Semiconductor Manufacturing (NYSE:TSM), has done so.  It has at least a two year fabrication lead over Intel, according to Jefferies analyst Mark Lipacis.

The earnings projections skyrocket for AMD stock if the company is able to garner 30% or even 50% of semiconductor chips. According to the Jefferies analyst, EPS could be as high as $4.50 with 30% or $6.50 with a 50% market share.

Since AMD stock is trading at $76.34, its P/E ratio would fall to 17 times earnings if earnings hit $4.50. So you can see that investors do not feel the present price is too high. In other words, they expect surprise earnings revisions. Just like the revenue and earnings revisions have crept up 9% in the last two months, they feel that this will continue to occur for the rest of the year.

Things Are Not So Bad At Intel

But not so fast. Things are not as bad as this picture assumes, according to Intel. Its CEO, Bob Swan, recently talked with Barron’s about their problems. He basically implied that the AMD advantage, which it shares with TSM, is not going to last.

For one, he believes that Intel’s 10 nanometer chips work as fast and have the same efficiency as AMD’s 7 nano-meter chips.

Second, they have identified the problems with their own 7 nanometer process technology issues. Intel believes its competitors have no more than a two-quarter advantage.

Third, Intel has an implied earnings advantage over AMD since it does not share the manufacturing profits with an outside company like AMD does. Intel produces all of the chips itself internally. This is expected to play out in their advantage over the long run.

What to Do With AMD Stock

In other words, Intel is fighting back. So AMD’s competitive lead might not last as long as analysts suggest. Having to rely on upward earnings revisions may not be as sound a strategy as one might think.

Yes, the risk here could be on the upside if AMD does actually pick up huge amounts of market share. But I wonder how long that could last as long as Intel is fighting back.

What I am suggesting here is use some caution. Analysts often get their projections very wrong. Buying a high P/E stock is a much riskier strategy than you might think.

On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.

Mark Hake runs the Total Yield Value Guide which you can review here.

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