For Chipmaker Advanced Micro Devices Stock, How High Is Too High?

Shares of Advanced Micro Devices (NASDAQ:) have blitzed higher in June, with AMD stock running from $27 to $34 in a matter of a few trading days. The catalyst? A few big product announcements and partnerships involving AMD, the sum of which have breathed life into the company’s market share expansion narrative. As a result, AMD stock has flown to new 52-week highs.

A Pair of Semiconductor Stock Buys: AMD and Micron (MU)

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But, with Advanced Micro Devices stock now trading at almost 50 times forward earnings and the average semiconductor stock trading at just 13x forward earnings, investors have to ask here: how high is too high for AMD stock?

From a long-term fundamentals perspective, $34 is too high. Reasonably aggressive long-term growth assumptions — 10%+ revenue growth over the next several years, on top of consistent gross margin expansion and opex leverage — support that $34 price tag on AMD stock. But, not until the end of fiscal 2019. We are already at that level in the second quarter of 2019.

As such, from a long-term fundamentals perspective, Advanced Micro Devices stock seems slightly overvalued today.

But, the stock has a ton of momentum, and the growth narrative is only gaining clarity and traction. As such, slight overvaluation won’t knock this stock off its winning course. Until these shares become wildly overvalued, consistent positive developments in the growth narrative will push AMD stock higher.

All in all, then, I think a neutral stance is best on AMD stock at the current moment. It’s not cheap enough to warrant buying into this rally. But, it’s not expensive enough to call the stock a sell, either. For the time being, the sidelines are the best place to be.

AMD Stock Appears Slightly Overvalued

The numbers here are easy to digest. Over the past 20 years, the has grown at a roughly 6% compounded annual growth rate. Over the next few years, growth should be roughly similar — if not slightly bigger — as IoT, AI, and cloud tailwinds continue to support healthy growth for the foreseeable future.

In that market, AMD should gain share. The company is presently winning CPU share from Intel (NASDAQ:) and GPU share from Nvidia (NASDAQ:). To be sure, Intel and Nvidia will fight back, and the AMD market share expansion narrative won’t be as friction-less as it has been. Nonetheless, there’s enough firepower over at AMD to warrant continued gradual market share expansion in the 6%-plus growing semiconductor market.

That implies that Advanced Micro should be able to easily grow revenue north of 10% per year over the next several years, with growth more likely coming in around the mid-teens range. Gross margins should run higher towards 50% as the company pushes into new, higher-margin product categories. The opex rate should fall to 25% as scale drives operating leverage.

Putting all that together, $2.70 seems like a doable EPS target for AMD stock by fiscal 2025 (from just 46 cents last year). Using a growth stock average 20x forward multiple, that implies a reasonable fiscal 2024 price target for AMD stock of $54. Discounted back by 10% per year, that equates to a 2019 target price of just under $34.

So, according to the long-term fundamentals, AMD stock is slightly overvalued here.

Growth Narrative Remains Vigorous

Slight overvaluation won’t be enough to knock AMD stock off its current winning course, and that’s because the momentum supporting the uptrend will more than offset slight overvaluation concerns.

The growth narrative at Advanced Micro Devices has been and continues to center around market share expansion. Specifically, AMD is a very small chip company ($36 billion market cap) relative to CPU giant Intel ($210 billion market cap) and GPU giant Nvidia ($90 billion market cap). But, AMD is currently winning CPU share from Intel, and GPU share from Nvidia. So long as this continues, there is viable runway for the stock to march towards a much larger market cap, and that viable runway will keep investors buying into AMD stock (so long as the valuation remains somewhat reasonable).

Consequently, so long as AMD keeps winning share from both Intel and Nvidia, and the valuation remains in check, AMD stock will likely trend higher.

Right now, this is exactly what is happening. AMD recently announced a multi-year partnership with Samsung wherein Samsung will use AMD graphics chips in its mobile devices. Only a few days later, Microsoft (NASDAQ:) announced that its latest and greatest Xbox console will be powered by AMD chips.

    In other words, AMD continues to win CPU and GPU contracts over Intel and Nvidia. If this trend persists, the AMD stock uptrend will be preserved.

    Bottom Line on AMD Stock

    AMD stock is on fire because its market share expansion narrative remains as vigorous as ever. Eventually, Intel and Nvidia will punch back, and this market share expansion narrative will slow. Once that happens, the uptrend in AMD stock will be challenged by valuation friction, since long-term fundamentals don’t support a mid-$30 price tag until late 2019 or early 2020.

    But, until the market share expansion narrative slows, the uptrend in AMD stock will remain alive and well, meaning that at current levels, AMD stock is neither an attractive long (fundamentals imply slight overvaluation) nor an attractive short (momentum implies continued strength).

    As of this writing, Luke Lango was long INTC and NVDA. 

    The post appeared first on InvestorPlace.

    The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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