U.S. Markets closed

Why AMD Stock Looks Good Up to $25… but Not Beyond

Luke Lango

In mid-January, I gave five reasons to buy shares of Advanced Micro Devices (NASDAQ:AMD). Those five reasons included server market share gains, GPU market share gains, M&A potential, a large addressable market and an attractive valuation.

Since then, the chipmaker reported strong fourth-quarter numbers, which broadly confirmed the bull thesis. AMD stock popped in response and, since my mid-January piece, AMD stock is up more than 15%.

After such a big rally, it is natural to question how much gas is left in the tank, especially for a highly volatile stock like AMD. The reality is that the company is still gaining share in the server and GPU markets, still has M&A potential and is still attacking a large addressable market. But two things have changed since mid-January. One, the valuation is larger now than before. Two, we got confirmation that AMD is not immune to macro-semiconductor industry headwinds.

InvestorPlace - Stock Market News, Stock Advice & Trading Tips

Thus, after considering those two factors, it does look like the better part of the rally in AMD stock is over. Having said that, this stock still has upside from here — and prices above $25 look achievable and are fundamentally warranted in 2019.

Big takeaway? There’s no harm in doing some profit taking here. But, by the end of the year, AMD stock has another 10%-plus upside.

Long Term Growth Drivers Remain Healthy

AMD’s fourth-quarter numbers confirmed that this company remains on a secular growth track, which will ultimately power AMD stock higher in the long run.

Namely, the numbers confirmed that AMD is executing well on its product roadmap, is successfully gaining share in the secular growth server and GPU markets, and is benefiting from continued profitability improvements. Revenues rose 6% in the quarter. Gross margins expanded 7 points year over year. EPYC processor shipments doubled sequentially. GPU datacenter revenues hit a new record high.

Overall, it was a very healthy quarter that came on the heels of largely disappointing updates from competitors Intel (NASDAQ:INTC) and Nvidia (NASDAQ:NVDA). The ostensible takeaway here is obvious: AMD is stealing share from its far larger peers.

So long as this remains true, the bull thesis in AMD stock will remain alive and well. This is a relatively small company ($23 billion market cap) attacking some very large markets, the sum of which concurrently support Intel ($225 billion market cap) and Nvidia ($90 billion market cap). AMD’s market share in those markets has historically been minuscule, but it’s rapidly growing and, as it does, AMD’s revenues, margins and profits are soaring.

Because the runway for potential growth is so huge, investors will naturally get excited every time AMD gains share in the server and GPU markets. So long as AMD keeps giving the market strong numbers which support this market share expansion narrative, AMD stock will head higher.

Right now, it looks like AMD will keep giving the market strong numbers for the foreseeable future. As a result, this company’s long-term growth narrative remains healthy and AMD stock will remain on a medium- to long-term uptrend.

There Are Some Near-Term Headwinds

There are, however, two sizable headwinds which will dilute potential returns in AMD stock in the near-term.

First, AMD’s fourth-quarter earnings report also showed that this company is not immune to inventory and demand issues, which are broadly plaguing the entire semiconductor industry. Nvidia has talked about these issues, and has consequently cut forward guides. Same with Intel. AMD was more of the same. Citing excess channel inventory in the graphics segment, AMD is guiding for revenues to drop more than 20% year over year next quarter.

So long as these excess inventory headwinds hang around, AMD stock will have trouble tacking on further gains.

Second, the valuation on AMD stock is now fairly extended. Earnings this year are expected to be 66 cents per share. At a $24 price tag, this implies a 36 forward price-to-earnings multiple, which is exceptionally expensive for this industry. To be sure, AMD’s earnings growth trajectory is equally exceptional, with EPS expected to be $1.11 by fiscal 2021. Assuming AMD continues to expand market share and grow revenues at a high single-digit rate, and boost margins, I think $1.75 EPS by fiscal 2023 is a solid target. That represents 30% growth per year from last year’s 46-cent EPS base.

Still, that isn’t enough to warrant huge upside in AMD stock. A growth-average 20 forward multiple on $1.75 EPS in fiscal 2023 implies a fiscal 2022 price target of $35. Discounted back by 10% per year, that equates to a fiscal 2019 price target of just over $25.

Bottom Line on AMD Stock

Strong fourth-quarter numbers underscored why AMD stock will be a winner in 2019. But with the stock already up nearly 30% year-to-date, upside above $25 seems limited.

As of this writing, Luke Lango was long INTC. 

More From InvestorPlace

Compare Brokers

The post Why AMD Stock Looks Good Up to $25… but Not Beyond appeared first on InvestorPlace.