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Advanced Micro Devices, Inc.'s (NASDAQ:AMD) Shares Climb 25% But Its Business Is Yet to Catch Up

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Advanced Micro Devices, Inc. (NASDAQ:AMD) shares have continued their recent momentum with a 25% gain in the last month alone. Looking back a bit further, it's encouraging to see the stock is up 39% in the last year.

Since its price has surged higher, given close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 17x, you may consider Advanced Micro Devices as a stock to avoid entirely with its 41.7x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

Advanced Micro Devices certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Advanced Micro Devices

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Want the full picture on analyst estimates for the company? Then our free report on Advanced Micro Devices will help you uncover what's on the horizon.

What Are Growth Metrics Telling Us About The High P/E?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Advanced Micro Devices' to be considered reasonable.

If we review the last year of earnings growth, the company posted a terrific increase of 437%. Pleasingly, EPS has also lifted 1,053% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 3.9% per year as estimated by the analysts watching the company. With the market predicted to deliver 13% growth each year, the company is positioned for a weaker earnings result.

With this information, we find it concerning that Advanced Micro Devices is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Final Word

Shares in Advanced Micro Devices have built up some good momentum lately, which has really inflated its P/E. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

Our examination of Advanced Micro Devices' analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

And what about other risks? Every company has them, and we've spotted 3 warning signs for Advanced Micro Devices (of which 1 makes us a bit uncomfortable!) you should know about.

If P/E ratios interest you, you may wish to see this free collection of other companies that have grown earnings strongly and trade on P/E's below 20x.

This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.