Investors would be forgiven for being skeptical of the recent big run in Advanced Micro Devices (NASDAQ:AMD) stock. AMD stock has gained more than 150% just since April, reaching a 12-year high.
But there are a number of concerns here. The huge gains in AMD stock have put valuation of the company’s earnings-per-share target above 30x for 2020. Traditionally, semiconductor stocks — including AMD at a few points along the way — received multiples closer to half that figure on this year’s earnings. AMD has been a bit of a disappointment over the years as well. Remember, this is a stock that barely two years ago traded at $2, and had some skeptics predicting bankruptcy once PC sales inevitably tumbled as smartphones took over.
Those concerns shouldn’t be dismissed out of hand, notably relative to valuation. But as I argued back in June, the gains in AMD stock are real — and deserved. Under CEO Lisa Su, this quite clearly is not the “same old AMD” — a key question heading into Q2 earnings that the company’s strong report answered in style.
Rather, AMD is becoming a force to be reckoned with in the chip space. The gains in AMD stock themselves show investors are starting to understand that. And if that’s indeed the case, there’s a long, long runway for AMD to grow revenue, improve margins — and lead the AMD stock price higher.
A Deserved Run
What’s interesting about the 150%-plus gains in AMD stock is that they’ve come pretty much solely due to the market’s changing sentiment toward AMD itself. This isn’t a case where a certain sector is hot, or money is flooding into a particular trend.
Rather, AMD has posted two blowout earnings reports — and investors are starting to see the company as an increasingly serious player in key end markets. That’s proven by the performance of AMD stock since April 24 — the day before its Q1 earnings release — against rivals and the chip space as a whole:
- AMD stock: +134%
- Nvidia (NASDAQ:NVDA): +23%
- Intel (NASDAQ:INTC): -7%
- Philadelphia Semiconductor Index: +11%
The relative outperformance by AMD is a sign that investors increasingly are pricing in more market share for Advanced Micro Devices. Whether it’s EPYC in datacenter, Ryzen in CPUs, or Vega in GPUs, investors clearly see AMD as a more potent competitor. And it’s not just AMD earnings making that case. Intel’s second-quarter report supported that contention as well.
Market share growth is exactly what bulls predicted at the beginning of last year. This isn’t the “same old AMD.” It’s not just a second-tier rival to Intel for PC makers like Dell Technologies (NYSE:DVMT) or Hewlett-Packard (NYSE:HPQ) looking for a lower-cost version to sell at Best Buy (NYSE:BBY). It’s becoming a real player — and in two very important markets.
A Long Path for Growth
Qualitatively, then, there are three potential growth drivers for AMD at the moment. And the good news is, despite the concerns about short-term cryptocurrency benefits, all three can drive AMD sales and earnings for years to come.
First, AMD can keep taking market share for a long time. It’s starting from basically zero in datacenter, and former Intel CEO Brian Krzanich already has admitted that figure could get to 15-20%. That doesn’t represent a long-term ceiling for AMD, either, even if competition from Nvidia will be intense. In CPUs and GPUs, AMD has room to take share off small bases as well — which allows more room for growth.
Secondly, its markets are better. Moving from heavy reliance on PCs to long-term growth markets like datacenter and gaming opens up “rising-tides-lift-all-boats” scenarios. Instead of Intel and AMD fighting tooth and nail for flat (at best) PC shipments, AMD benefit from share and market growth.
Third, those growing markets and better products in turn give AMD some actual pricing power. Gross margins have been a long-running concern for AMD stock, with an inability to drive expansion keeping overall profits down. But gross margins rose 3 points year-over-year in Q2. Further expansion adds another potential driver to AMD earnings growth.
AMD Stock Is Expensive
That said, AMD stock has doubled in about three and a half months. At 35x forward earnings, AMD stock no longer is cheap — or close. And that could be a concern.
But fundamentally, AMD still has room for growth. Operating margins were barely 10% in Q2, and about 9% in Q1. Between further gross margin expansion and operating leverage, those margins can rise. Tack on a bit of financial leverage and revenue growth, and AMD earnings can rise steadily for the next few years if market share gains continue.
AMD’s valuation admittedly is high — but it’s a valuation the company has a path to grow into. And what the market is saying of late is that it sees that path as being something close to wide open.
As of this writing, Vince Martin has no positions in any securities mentioned.
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