Advanced Micro Devices (AMD) saw a dramatic drop from about $220 per share in March 2024 to roughly $76 by April, coinciding with Liberation Day. Surprisingly, the stock has since bounced back, surpassing the $220 mark in less than half a year.
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This increase can be partly attributed to a wider rebound in U.S. stocks, but there’s more to it. AMD’s core business is improving; particularly, its data center segment is enjoying robust growth in AI accelerators and server CPUs, which are crucial for performance. Enhanced efficiency and cost-effectiveness for upcoming models like the MI350 and MI400 have spurred optimism, leading to projections of increased revenue and profit.
The real turning point came in early October, when AMD revealed a multi-year partnership with OpenAI, renewing excitement about the company’s prospects for growth.
Quarterly results suggest that prior market predictions may have been too cautious. Currently, with valuation multiples approaching historical highs, much of the positive sentiment may already be baked into the stock price. Given the strong execution against rising expectations, I think AMD is fairly valued at this stage and recommend holding onto shares.
Next-generation GPUs and OpenAI fuel AMD’s breakthrough
Tech giants are undergoing a transformation driven by the AI boom, and even those initially lagging can rocket to the top seemingly overnight. AMD is a prime example: On October 6th, the company announced a significant, long-term deal with OpenAI to supply GPUs, resulting in a nearly 40% surge in just three trading days. It seems we’re truly in the age of AI stocks.
As part of this deal, OpenAI also has the option to buy 160 million AMD shares for merely $0.01 each. If they choose to exercise this fully, OpenAI could hold about 10% of AMD’s stock at a minimal cost, which could be worth a fortune at current valuations.
This agreement is a win-win. For AMD, it’s projected to generate about $100 billion in revenue over the next four years, ensuring that it has key customers for its next-gen GPUs like the MI450 for years to come. This signals to the market that AMD is finally in a position to compete with Nvidia. For OpenAI, it means securing 6 gigawatts of computing resources, starting with the MI450 expected to be in operation by late next year.
As a result, AMD’s long-term earnings predictions have been significantly revised upwards. Six months ago, estimates for AMD’s five-year sales growth rate were around 16.6%, and these have now jumped to 22.6% post-agreement, making the dramatic rise in AMD’s stock price understandable.
GPU-starved environment
The phrase “demand is better than expected” is always a welcome sound, especially for AI-driven firms that are benefiting from the mismatch of soaring demand and limited supply.
This time, though, it wasn’t AMD or Nvidia making that claim; it came from one of their major customers, Microsoft. The tech giant has noted that the crunch in data centers is likely to last longer than anticipated. Despite its substantial investments in cloud infrastructure, the demand for cloud computing is outstripping its capacity for expansion—a scenario mirroring the soaring need for AI computing power, especially for handling large-scale language models.
So, where does AMD fit in? Well, GPUs are the critical components driving AI data centers. While Nvidia dominates this field by a significant margin, AMD stands out as a dependable alternative for companies like Microsoft. The adoption of AMD’s MI series accelerators (like the Instinct MI300X) in AI clusters is gaining traction, and Microsoft has announced plans to integrate these chips into its data centers. Effectively, AMD is tapping into the same growth areas contributing to labor shortages for Microsoft, setting the stage for increased pricing power and potential profit margins as demand surpasses supply.
Accordingly, this led to an upward revision in AMD’s long-term earnings per share (EPS). Just a month ago, projections for a five-year EPS growth rate were at 26.9%, and these have now climbed to 29.2% for the same period.
Has the market already calculated the profits?
Some might suggest that these revisions have already factored in most of the potential upside, as AMD’s stock has rebounded from its lowest forward price-to-earnings ratio of about 20x in April to around 55x now, indicating that it is likely fairly valued based on these new catalysts.
In my opinion, AMD is still trading below its all-time high forward earnings multiple of over 63x from earlier in 2024, but approaching that level means there is little tolerance for error moving forward.
AMD is set to report its third-quarter earnings in about three weeks (early November). They expect sales of roughly $8.7 billion, while analysts are slightly more optimistic, predicting $8.73 billion. While the overall partnerships and GPU demand signal long-term bullishness, there’s some nuance in the short term. In the CPU market, for instance, AMD could face renewed competition from Intel, now teamed up with Nvidia, which may seek to reclaim market share that AMD has captured in recent years.
Additionally, concerns linger about pressure on profit margins. In the second quarter, AMD faced challenges due to strict U.S. export controls, resulting in a GAAP gross profit margin of 40%, down from 49% during the same period last year. This decline impacted its data center division, which reported an operating loss of $155 million, a stark contrast to an operating profit of $740 million the prior year.
Considering these challenges, it seems rather probable that short- to medium-term results could temper AMD’s momentum. With the stock trading at high multiples, it appears to have already discounted much of the potential long-term upward movement.
Is AMD a buy, hold, or sell?
Overall, Wall Street sentiment is generally positive for AMD, but there remains room for skepticism. Among 38 analysts tracking the stock, 28 express a bullish outlook, with the remaining 10 neutral and none bearish. The average price target sits at $243.29, suggesting about an 8% upside from the current price over the next year.
AMD’s rally comes with conditions.
At the moment, AMD appears to be the only company capable of directly challenging Nvidia. Recent dynamics—like the partnership with OpenAI and persistent demand for AI technology—point toward more predictable growth for both revenue and profits going forward. Yet, the significant bounce in stock price over the past half-year suggests that perceptions of closing the gap with Nvidia are already included in the valuation.
That said, I would advise a cautious hold on AMD. The current valuation seems precarious given the potential for volatility in the upcoming quarters. AMD finds itself in a situation where it has to exceed expectations to keep momentum, and the chances of seeing prices drop back to mid-2024 levels may be higher than the chances of continued significant gains—at least until new evidence suggests otherwise.
