Looking at AMD (NASDAQ:AMD) stock gave me a chance to revisit the 1966 Spaghetti Western film “The Good, the Bad and the Ugly.” Was I just procrastinating or did Clint Eastwood have some hidden insights to share with AMD stock investors?
Like Sergio Leone’s epic movie, I found some “good” in Advanced Micro Devices shares. To be sure, there’s some “bad,” that is, risks that need to be considered. And, ultimately, I discovered some “ugly” that investors should examine before pulling the trigger on AMD stock. And it won’t be as treacherous as the film’s race to find a fortune in gold buried in a cemetery.
What’s Good About AMD Stock
Advanced Micro Devices stock has performed very well in 2020, with year-to-date performance of over +100% as of recent days. It’s less than $5 off the 52-week high price of almost $98. For those investors who jumped in during the March 2020 stock market crash, significant profits have been made.
The company has a very strong balance sheet with plenty of cash, low levels of debt. And it is a growth stock to consider as Zacks estimates that the stock will have an expected earnings-per-share growth of +49.53% for the next three-to-five years.
The Q3 financial results released in late October 2020 were strong and have sparked a rally in AMD stock. Some key points to mention are as follows:
- Record revenue grew 56% and net income and EPS more than doubled year-over-year.
- Revenue was $2.80 billion, up 56% year-over-year and 45% quarter-over-quarter
- Gross margin was 44%, up 1 percentage point year-over-year and flat quarter-over-quarter
- Operating income was $449 million compared to $186 million a year ago and $173 million in the prior quarter
- Net income was $390 million compared to $120 million a year ago and $157 million in the prior quarter.
Dr. Lisa Su, AMD president and CEO, is optimistic about future business prospects. She mentioned that “We reported our fourth straight quarter with greater than 25 percent year-over-year revenue growth, highlighting our significant customer momentum. We are well-positioned to continue delivering best-in-class growth as we further extend our leadership product portfolio with the launches of our next-generation Ryzen, Radeon, and EPYC processors.”
Overall, it was a very solid quarter for AMD stock, and investors have pushed the shares to make a new 52-week high.
According to a Fortune Business Insights report, prospects in the semiconductor space show decent growth for the coming years. “The global semiconductor market size stood at $513.1 billion in 2019 and is projected to reach $726.7 billion by 2027, exhibiting a CAGR of 4.7% during the forecast period.”
But not all factors are bright, or good, for AMD stock.
Now, For The Bad
Advanced Micro Devices is the chipmaker for Xbox made by Microsoft (NASDAQ:MSFT) and the Sony (NYSE:SNE) PlayStation 5. There was a very big development released by Microsoft that can harm sales of several chipmakers, including Advanced Micro Devices and Intel (NASDAQ:INTC). Bloomberg reported that Microsoft is working on designing its chips made both for servers and other personal computers.
What else is bad for AMD stock? Despite what some might see as having its merits, I see a negative in the announcement that AMD will acquire Xilinx (NASDAQ:XLNX) in an all-stock transaction for about $135 billion.
This strategic acquisition will probably add value in terms of diversification, and economic synergies. So why is it a bad thing? The answer is simple, AMD is paying too much to acquire Xilinx.
AMD is using its skyrocketing stock price to acquire another company which also has a stock price that surged in 2020. From a timing point of view, related to merger and acquisition activity, I believe that AMD will be paying too much for this deal. And, to make matters worse, this deal is likely to raise regulatory issues.
One more bad thing about AMD stock is that although it has positive free cash flow for 2019 and the trailing 12 months there is not a stable trend for it. For 2017 and 2018, the company reported negative free cash flows. I would love to see both a stable positive trend for free cash flow and a sustainable trend as well. This is not the case so far.
Finally, Here’s What’s Ugly About AMD Stock
This is the bottom line for the AMD stock. The ugly thing about AMD stock is its current price, which makes expensive and significantly overvalued, too.
Data from CSIMarket shows that for AMD stock’s Price/Earnings ratio (TTM) is 130.23, Price/Sales (TTM) is 13.48, the Price/Cash Flow (TTM) multiple is 95.45 and Price/Book is 35.76. Now on a relative valuation analysis, the relevant key financial ratios for the semiconductors industry are as follows:
The P/E of 40 for the Q3 2020 for the industry. As for the other key ratios, P/S is at 6.89, the P/CF ratio is at 16.91, and P/B is at 6.87. All of them are well below the financial ratios of AMD.
Taking into consideration all these four key financial metrics, AMD stock on a relative basis is overvalued compared to its industry.
The valuation concern is the ugliest thing about AMD stock. After the good and the bad, take this valuation highlight into consideration should you decide to add Advanced Micro Devices to your list of growth stocks for 2021.
Paying too much for a stock is never a good investment idea unless of course history proves this to be wrong.
On the date of publication, Stavros Georgiadis, CFA did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Stavros Georgiadis is a CFA charter holder and an Equity Research Analyst, Economist with an MSc in Applied Economics and Finance from the Athens University of Economics and Business. You can connect with Stavros on LinkedIn.