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Advanced Micro Devices Is in a Strong Spot

Investor Place · 11/11/2021 06:00

InvestorPlace - Stock Market News, Stock Advice & Trading Tips

The semiconductor shortage has underscored just how important the little devices are. They’re in just about everything these days and the companies that make them are raking in the cash because of it. One such company is Advanced Micro Devices (NASDAQ:AMD). AMD stock has been a strong performer over the past few years as its chips power things like phones, computers and drones.

What to Expect From AMD Stock Ahead of July's Earnings Report
Source: Fabio Alcini / Shutterstock.com

But it’s the group’s latest contract win that has investors buzzing: a deal with company formerly known as Facebook, Meta (NASDAQ:FB).

The stock shot up 10% on the news despite very few details on its financial impact on the company. But the market was excited, perhaps rightfully so. Facebook’s in the process of building an exciting new internet world and it’s using AMD chips to do it.

The semiconductor space isn’t a cheap one to invest in. The high price-earnings ratios can be off putting for value investors, but a closer look suggests AMD stock isn’t as expensive as it may appear.

Is AMD Stock Overvalued?

AMD stock currently trades at 47x its expected earnings. That’s expensive by almost every measure and well beyond the group’s historical average. However, when you take into account expected growth it doesn’t look all that expensive. AMD’s PEG ratio is 0.83, and anything around 1 is considered desirable. Nvidia (NASDAQ:NVDA), for example, carries a PEG ratio of 1.82.

A Look Under the Hood

AMD’s also got some pretty solid financials to back up it’s price tag. The most recent set of results showed a 54% increase in sales but more importantly, operating income more than doubled. It’s this leveraged aspect of AMD’s business that makes it such an attractive investment. Operating margins reached above 16% for the first time last year and are expected to continue rising in the years ahead. Having a product that’s in high demand is one thing, but finding an increasingly profitable way to deliver it is the cherry on top. 

Growth in the tech sector is typically marred by a lack of profits, but that’s not the case among semiconductors. AMD had $777 million left over after funding its operations last year, and that’s expected to more than triple this year.

So with all that in mind, AMD sounds like somewhat of a sure thing. But if you’ve read this far you surely know there’s no such thing when it comes to stock picking. This is no exception. While AMD is certainly attractive, it does come with risks.

AMD’s Key Risks

Above, we discussed by AMD’s expected growth somewhat justifies it’s lofty P/E, but the key word here is expected. There’s no denying that expectations for AMD stock are high. So far, the group’s been able to live up to the hype, but it’s important to consider that a misstep could cause some near-term volatility. It’s never a good thing when a company doesn’t deliver on growth targets, but the market’s reaction is often amplified when you’re talking about a high-growth company like AMD.

The semiconductor shortage and global supply chain issues increase this possibility for AMD stock. There’s also a risk that cost inflation starts to eat into margins as well. AMD is somewhat insulated from this as the group’s customers are probably buying based more on chip performance rather than price, so there’s some room to pass on rising input costs. However, at some point volumes could take a hit.

Semiconductors are also a cyclical business, meaning their fortunes wax and wane with the economy. This could be somewhat muted by fast growth in cloud computing and connectivity, meaning even as economic growth slows, growth within those industries will continue with strength. But ultimately slower economic growth means businesses have less to spend on new technology and that’s a bad thing for AMD stock.

The Bottom Line

The important thing to consider is that every investment comes with a degree of risk and no one can predict the direction of the global economy with certainty. However, none of these risks are AMD-specific and would impact the entire sector.

With that in mind, AMD stock looks like a strong pick within the sector with plenty of room to run ahead. It’s a cheaper pick than Nvidia and a higher-growth play than Intel (NASDAQ:INTC). As semiconductor stocks go, AMD is the goldilocks pick of the bunch. 

On the date of publication, Laura Brodbeck did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Laura Brodbeck has a Finance degree from Duquesne University and has been writing about financial markets for the past 8 years. Her work can be seen in a variety of publications including InvestorPlace, Benzinga, Yahoo Finance and CCN.

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