It’s tough to be the top-performing stock in the S&P 500 index for a whole year. It’s far tougher to do it in back to back years. But, chip giant Advanced Micro Devices (NASDAQ:AMD) may do just that. Last year, AMD stock was the gauge’s best performer, rallying more than 68% while the index lost almost 7%.
In 2019, AMD stock is up another 54%, making it one of the top five year-to-date performers in the S&P 500, which is up 14.5%
Can AMD stock do it? Can the chip giant repeat as the S&P 500’s top stock in 2019?
I’m not convinced. The year-to-date rally in AMD stock has been big. Too big. While the underlying fundamentals are consistently improving, the valuation looks stretched in the near to medium term, even if those fundamentals continue to improve. Indeed, at $30, AMD stock looks overvalued.
As such, I think caution is best warranted on AMD stock here and now. Earlier this year, with the stock trading hands around $20, I was bullish, because the valuation didn’t price in sufficient upside from market share gains. Now, with the stock trading hands around $30, the situation is different. Namely, the valuation prices in too much upside from market share gains, and is due for a reset on any operational hiccup.
Big takeaway? Be careful. This rally in AMD stock may start to falter at $30.
Fundamentals Look Good
The big and extended rally in AMD stock through 2018/19 can be summed up in three words: market share gains.
In short, AMD has long been the little guy in the CPU and GPU markets, overshadowed by CPU giant Intel (NASDAQ:INTC) and GPU giant Nvidia (NASDAQ:NVDA). To be sure, AMD is still the small player, but the company is quickly gaining share on its bigger rivals. Namely, AMD is rolling out next-gen chips more quickly than Intel, and is rapidly gaining CPU market share. That’s happening as AMD is stepping up its game in the GPU market, winning share away from Nvidia.
Bulls are getting excited. The idea here is that you have a David who could turn into a Goliath, and that this process will power huge revenue and profit growth, the sum of which will drive big gains in AMD stock. The math checks out. AMD is a $30 billion company. Intel is a $250 billion company. If AMD continues to gain share on the chip giant, then the runway for potential value creation in the long run is quite compelling.
Right now, this “David is gaining on Goliath” thesis is only picking up steam. Specifically, Alphabet (NASDAQ:GOOGL) recently launched its new cloud streaming gaming platform Stadia, and they tapped AMD — not Nvidia — for GPUs. Further, although the implication is that Stadia will use Intel CPUs, Alphabet wasn’t very specific about it, and left the door open for AMD CPU implementation in the future. Also, Digitimes recently reported that Hewlett-Packard and Lenovo “have been placing orders for AMD’s CPUs for their notebooks since the second half of 2018” amid Intel CPU shortages.
All in all, the market share expansion thesis today is as strong as ever. That means that the outlook for David whooping Goliath remains as favorable as ever, too. That’s why AMD stock is on track for another record year.
Valuation Does Not Look Good
Although the long-term growth narrative supporting AMD stock remains healthy, the valuation seems overly optimistic as Advanced Micro Devices stock closes in on $30.
The global semiconductor market has healthy tailwinds in AI and data which support further growth over the next several years. But, the market appears slightly overextended here, and due for slower growth ahead, thanks to reduced demand tailwinds and more significant supply build headwinds. My math suggests the global semiconductor market will grow at a 1-2% annualized rate into 2025.
Based on its SEC filings and market numbers from the Semiconductor Industry Association, AMD’s share of the global chip market was roughly 1.4% last year. At it’s peak, AMD controlled just shy of 3% of the market about a decade ago. Assuming AMD continues to gain CPU and GPU share, then its global semi market share could reasonably hit 3% again by 2025. Concurrently, gross margins should ramp towards 45%, and the opex rate should fall back towards the mid-20% range.
Modeling out all that, $2 in EPS seems achievable for AMD by fiscal 2025. Based on a forward price-earnings multiple of 20x, which is average for growth stocks, that equates to a fiscal 2024 price target for AMD stock of $40. Discounted back by 10% per year, that implies a reasonable fiscal 2019 price target for AMD stock of roughly $25, nine bucks below current levels.
Bottom Line on AMD Stock
The long-term growth fundamentals underlying AMD stock are favorable. The valuation today is not. Consequently, Advanced Micro Devices stock needs to cool off after a 60% year-to-date rally.
The shares will likely hit resistance around $30, a level which has proven unsustainable in the past, and drop back toward $25 over the next several months. Following that correction, the shares will resume their longer-term uptrend. But, AMD stock is due for some turbulence here and now.
As of this writing, Luke Lango was long INTC and GOOGL.
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