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A 20% Drop in 1 Month: Is It Time to Buy the Dip on AMD Stock?

Vaseline 4 weeks ago

This chip stock has fallen sharply in a short time, but the investment thesis is the best ever.

The semiconductor industry fell hard on April 17 after news from the equipment manufacturer ASML lost income and that competition from China is increasing.

Advanced micro devices (AMD -5.44%)which at one point was one of the best performing S&P500 components has plunged 21% in just one month so far this year and is now at a three-month low.

Despite the sell-off, expectations for AMD are still incredibly high. Let’s look at the growth stocks to see if it’s worth buying now or if the risks outweigh the potential reward.

Rendering of a person's head on a chip illustrating the concept of artificial intelligence.

Image source: Getty Images.

AMD’s transformation

AMD has been in the shadows of for decades Intel and other competitors when growth leveled off. But one look at AMD’s annual revenue chart and it’s easy to see that the company has pole vaulted into a hyper-growth stock.

AMD Earnings Chart (TTM).

AMD Revenue (TTM) data by YCharts

AMD has long depended on its PC and video game segments to drive growth. But in recent years, two other segments have been added: embedded and data center.

The embedded segment took off largely thanks to AMD’s $49 billion acquisition of Xilink, completed in February 2022. The segment focuses on integrating central processing units (CPUs) and graphics processing units (GPUs) into single-chip solutions for field programmable gate arrays (FPGAs), which have numerous applications across industries, and adaptive system-on-a-chip (SoC) products, where system components are compressed onto a single piece of silicon.

The takeover was largely a game of artificial intelligence (AI). It helped pave the way for the June 2023 launch of AMD Versal Premium VP1902 – the world’s largest SoC specifically aimed at AI workloads.

The second growth catalyst is AMD’s data center business, which makes CPUs, GPUs, data processing units (DPUs), FPGAs, and adaptive SoC products for data centers to help them handle the massive computing power needed to run AI models.

The customer segment focuses on solutions for desktops and PCs, and the gaming segment mainly on GPUs and SoCs for gaming.

Metric

Fiscal 2020

Fiscal 2021

Fiscal 2022

Fiscal 2023

Data center revenue

$1.69 billion

$3.69 billion

$6.04 billion

$6.5 billion

Data center operating result

$198 million

$991 million

$1.85 billion

$1.27 billion

Data center operating margin

11.7%

26.9%

30.6%

19.5%

Customer revenue

$5.19 billion

$6.89 billion

$4.65 billion

$6.2 billion

Customer’s operating result

$1.61 billion

$2.09 billion

($46 million)

$1.19 billion

Customer operating margin

31%

30.3%

(1%)

19.2%

Gaming revenue

$2.75 billion

$5.61 billion

$6.21 billion

$6.81 billion

Business revenue from gaming

($138 million)

$934 million

$971 million

$953 million

Gaming operating margin

(5%)

16.7%

15.6%

14%

Embedded revenue

$143 million

$246 million

$5.32 billion

$4.55 billion

Embedded business results

($11 million)

$44 million

$2.63 billion

$2.25 billion

Built-in operating margin

(7.7%)

17.9%

49.4%

49.5%

Data source: AMD.

AMD’s embedded and data center segments were virtually non-existent a few years ago. They also have the potential to be higher-margin segments than PCs, desktops and gaming, paving the way for AMD to grow its revenue and profits faster.

High expectations

AMD shares rose in 2023 and into 2024 due to the company’s good position to generate revenue from AI in its segments. The biggest challenges for AMD are competition, sustainable investments in AI and the cyclicality of the semiconductor industry. But from an investment perspective, AMD needs to justify its expensive valuation with growth.

Analyst consensus estimates call for fiscal 2024 diluted earnings per share (EPS) of $3.63 and fiscal 2025 diluted earnings per share (EPS) of $5.51. AMD reports its first quarter 2024 earnings on April 30, meaning we’re still just over nine months away from the company’s full-year 2024 results.

For context, AMD earned $2.57 in diluted earnings per share in fiscal 2021, so fiscal 2025 is expected to double from that level. AMD has a price-to-earnings ratio of 42.4 and a price-to-earnings ratio of 27.9 based on fiscal 2025 earnings. It needs to deliver some serious growth for the stock to look reasonable, but AMD will will look cheap as the share price languishes and profits look like they can continue to grow at a solid pace beyond the 2025 fiscal year.

In the short term, some of the biggest opportunities for AMD are increasing its share of the AI ​​chip market. On April 16, AMD announced new products for its commercial mobile and desktop AI PC portfolio. Investors should monitor how customers receive these new products in the coming quarters. Another possibility is that AMD could capture the market share of AI GPUs Nvidiawhich currently has a virtual monopoly.

A better way to approach AMD stock

AMD could be in for a bumpy ride in the near term due to factors within and beyond its control. A better way to invest in the company is to think about where it will be in a number of years, not where it will be if it meets next quarter’s or this fiscal year’s expectations.

AMD’s ticket to success is to compete on innovation and price in its business segments. In retrospect, the Xilinx acquisition looks brilliant because AMD can now leverage its diversified product offering across multiple segments. AMD still has a lot to prove, but it’s notable that it has a clear path to gaining market share, while Nvidia appears to have more to lose. But both companies should do well as long as the overall market continues to grow.

Because AMD’s valuation is based on earnings that are still relatively far into the future, the stock could be under enormous pressure if growth slows or if there are broader industry headwinds. I think AMD is worth leaving on the watchlist or simply buying into an entry-level position in for most investors, at least until we get a better idea of ​​AMD’s role in the AI ​​PC market.

AMD has high margin potential in its business segments, but margins are still relatively low compared to Nvidia and other chip companies. AMD must prove that its revenue growth and margin expansion have room.

Despite these challenges, investors with a higher risk tolerance looking to add an AI stock to their portfolio could use the sell-off as a buying opportunity.

Daniel Foelber has the following options: July 2024 long calls of $180 on Advanced Micro Devices. The Motley Fool holds positions in and recommends ASML, Advanced Micro Devices, and Nvidia. The Motley Fool recommends Intel and recommends the following options: long January 2025 $45 relying on Intel and short May 2024 $47 relying on Intel. The Motley Fool has a disclosure policy.