Despite Positive Catalysts, AMD Stock Remains Priced For Perfection

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Thomas Niel

Mon, Sep 23, 2019, 3:01 AM

But is the latest price action mere calm before the storm, or is Advanced Micro Devices stock setting itself up for material upside? In the CPU realm, the company is slowly eating Intel’s (NASDAQ:INTC) lunch. With GPUs, they are holding their own against arch-rival Nvidia (NASDAQ:NVDA).

AMD’s valuation remains a concern. The company trades at a substantial premium to both Intel and Nvidia. The price to book multiple is 17.41, while Intel’s is 2.99 and Nvidia’s is 10.17, according to Morningstar data, while its triple-digit price to earnings multiple of 166x dwarfs the rival’s respective 11.53x and 39.98x.

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With a history of boom and bust cycles, is this a red flag? Let’s take a closer look, and see what’s the verdict for investors entering AMD stock today.

Recent Wins for AMD

AMD continues to gain an edge in the CPU and GPU markets. In the CPU space, the company was previously an also-ran against powerhouse Intel. But recent wins have set the momentum. Earlier this month, InvestorPlace contributor Chris Tyler analyzed the choice of AMD’s EPYC chips by Alphabet (NASDAQ:GOOGL) and Twitter (NYSE:TWTR) for their data centers. Tyler cited analysis from Atlantic Equities that estimated AMD could grow data center market share from 2% to 25% within a decade. This alone could move the needle for Advanced Micro Devices stock.

Among personal device CPUs, AMD is making moves as well. Microsoft (NASDAQ:MSFT) may choose AMD’s Ryzen CPUs to power its Surface Laptop 3. On the GPU front, AMD continues to gain ground on Nvidia. For the quarter ending June 30, 2019, the company gained significant market share in the add-in-board (AIB) GPU space. AMD’s share of the AIB market grew to 32.1% from 22.4%.

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But will these recent wins translate into improved profitability? While the company is making inroads on Intel and Nvidia, both rivals are now willing to put up a fight. Intel has vowed to “get more aggressive” to counter loss of CPU market share. AMD has previously been on the offense in a price war with Nvidia. Nvidia has decided to compete on performance. But if AMD’s market share continues to climb, Nvidia could turn to price cuts to maintain their position.

Is the Opportunity Worth the Current Valuation?

The valuation of the GPU stocks relative their broad-line peers continues to boggle me. As I remarked last week, AMD stock and NVDA shares trade at high forward price/earnings (forward P/E) and enterprise value/EBITDA (EV/EBITDA) ratios. Of the two GPU players, AMD’s valuation is the most frothy. AMD’s forward P/E is 65.1x. Its EV/EBITDA is 66.1x. This is leaps-and-bounds above NVDA’s valuation multiples (forward P/E of 43.4x, EV/EBITDA of 39.7x).

Does that mean AMD is overvalued and NVDA is a value play? In my mind, both stocks have material downside risk. Investors have bought into the ambitious growth story both companies are selling. I concede both firms have strong catalysts, but both are still recovering from a weak GPU market. Both need to at least reach the high-water mark set in 2018.

Besides a rich valuation, AMD comes with a few red flags. As InvestorPlace’s Ian Bezek wrote on Sept. 19, Advanced Micro Devices stock has a dilution problem. Since 2009, share count has jumped ~62%. This comes as the company’s profitability has not dramatically changed in the past decade. The U.S.-China trade war also remains a risk. While things have cooled down, upcoming trade talks are tough to handicap. If things take a turn for the worse, AMD could lose big. China represents 30% of AMD’s business.

High Chance the AMD Stock Price Goes Lower

AMD stock has the momentum to prove the bears wrong. The company’s wins in the CPU and GPU markets could continue through the next decade. But the cyclical nature of the business remains.

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Advanced Micro Devices stock is dependent on several macro factors. The company has gained a short-term upper hand. But a price war on both the GPU and CPU fronts could make profitability a greater challenge. The unpredictable trade war could revert back to acceleration, which could significantly impact AMD’s business. Given the stock’s boom-and-bust history, the AMD stock price could have material downside.

With these risks in mind, I remain on the sidelines with AMD stock. The company could prove me wrong and shares could rally higher. But given the rich valuation and high expectations, look elsewhere for stronger investment opportunities.

As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.