Advanced Micro Devices, Inc. (NASDAQ:AMD) faced a challenging week as investors reacted negatively to the company's recent earnings guidance, which fell short of expectations for some. AMD reported its Q3 2024 earnings on October 29, delivering results that, while acceptable, failed to excite the market. The stock dropped approximately 12% on October 30 following the report and continued to slide, closing at $134.9 on November 15, 2024. YTD, AMD is down around 8.5%, a large disparity to its direct competitor Nvidia (NASDAQ:NVDA), which has surged 187% in the same period.
AMD Data by GuruFocus
While there are differences in their progress, it's difficult to justify AMD's decline in a year dominated by the AI investment narrative. As one of the strongest players in the AI infrastructure space, AMD has made notable strides to strengthen its position. Over the past year, the company has taken critical steps to narrow the gap with Nvidia, including developing an alternative to Nvidia's CUDA framework and acquiring companies with competitive AI software offerings, such as Silo AI in Europe and ZT Systems. In my opinion, investors are giving up on AMD too soon. This article will highlight the progress AMD has made in its AI software ecosystem, analyze its fundamentals based on its Q3 2024 earnings, evaluate its valuation and risks, and explain why I believe the stock remains a compelling buy, contrary to the market's opinion.
Is the Market Overreacting?While the company delivered solid results, Wall Street analysts seem concerned about whether AMD can sustain growth in the coming year. Morgan Stanley (NYSE:MS) analyst Joseph Moore highlighted AMD's achievements, particularly in AI, noting that $5 billion in revenue from a new product is impressive. However, Moore also warned that expectations are exceptionally high, predicting limited sequential growth in CY25 unless AMD takes significant market share, which he doesn't foresee. He adjusted his price target to $169, down from $178. For me, these concerns seem overly short-term. Even in a conservative scenario where AMD doesn't gain much market share from Nvidia, the company still remains a big player in AI infrastructure space. Considering the AI market is projected to grow at a CAGR of 60%, reaching a $500 billion total addressable market (TAM) by 2028, AMD should see substantial growth simply by operating in this space.
I believe the market's current pricing reflects a focus on short-term gains, ignoring the longer-term trends that are integral to AMD's intrinsic value. As an investor, I don't get caught up in daily or weekly fluctuations. In my opinion, as long as AMD's fundamentals and key value drivers remain strong, the long-term outlook for the stock is promising.
AMD's Path to Closing the Gap with NvidiaA key reason AMD trails Nvidia in selling GPUs to major AI infrastructure providers like Amazon (NASDAQ:AMZN)'s AWS, Microsoft (NASDAQ:MSFT) Azure, and Google Cloud Platform is Nvidia's proprietary CUDA framework. CUDA tightly integrates with Nvidia GPUs, giving the company a significant competitive advantage. However, this may no longer be a roadblock. Spectral Compute has developed Scale, a tool that allows CUDA to work with non-Nvidia chips, including AMD's. AMD has also made strides in its software ecosystem. CEO Lisa Su announced that several essential open-source AI technologies now support AMD's ROCm framework, including Meta (NASDAQ:META) Platforms' Llama, SGLang, and Alphabet (NASDAQ:GOOGL)'s TensorFlow. These advancements could make AMD a viable open-software alternative to Nvidia's AI solutions, positioning the company to attract a broader customer base.
On the hardware front, AMD is ramping up production of its next-gen Instinct MI325X GPUs, which are expected to compete directly with Nvidia's H200 Hopper GPUs. AMD plans to begin shipping these chips in Q1 2025, with its MI350 series slated for release in the second half of 2025. While Nvidia maintains a lead of 612 months with its B300 series Blackwell GPUs, AMD's MI400 series, scheduled for 2026, is designed to close the gap entirely. Even if AMD doesn't fully catch up to Nvidia, it is expected to secure a significant position as a reliable second source for GPU AI accelerators. The company's consistent progress in hardware and software reinforces its ability to capitalize on the rapidly expanding AI infrastructure market.
Reviewing AMD's Q3 PerformanceFrom a long-term investment perspective, AMD's recent results reinforce its place in a well-balanced portfolio. In Q3 2024, AMD reported revenue of $6.8 billion, reflecting an 18% YoY increase and surpassing analyst expectations of $6.7 billion. The standout achievement here mainly came from AMD's Data Center segment, which delivered an impressive 122% YoY growth. This basically outlines AMD's vital role in the AI infrastructure market, driven by increased shipments of Instinct GPUs and strong demand for EPYC CPUs. The numbers align with broader industry trends, as Goldman Sachs (NYSE:GS) projects a 160% rise in global data center demand by 2030. Additionally, McKinsey estimates that meeting U.S. data center capacity needs alone will require $500 billion in infrastructure investment by the decade's end. These projections affirm the long-term growth thesis for AMD, which remains intact following its Q3 results.
Balancing Segment Strengths and WeaknessesWhile AI-related revenue is soaring, AMD's Gaming and Embedded segments faced challenges this quarter. Gaming revenue declined 69% YoY, primarily due to a slowdown in console orders as the market awaits new models. Meanwhile, Embedded revenue fell 25% YoY, likely due to clients reducing orders amid rapid technological change and concerns about inventory buildup.
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Despite these setbacks, the Data Center segment's strength compensates for the softness in these areas. With AI driving significant demand, I believe AMD's management will be prioritizing investments in this segment to capitalize on the growth opportunity while the market is still expanding. The Client segment, which reported a 29% YoY increase in revenue, performed well but deserves less focus compared to the Data Center business. By reallocating capital and resources toward AI-related ventures, AMD will be able to better position itself to maintain momentum in the face of growing competition.
Margins and Cash Flow PerformanceAMD has made progress in improving its operating leverage, as gross profits rose 18% sequentially, driven by strength in the Data Center segment. Consolidated gross margins increased by 3 percentage points YoY and 1 percentage point QoQ, while GAAP operating income surged 223% YoY to $724 million, resulting in a GAAP operating margin of 11%up 7 percentage points from a year ago.
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On a non-GAAP basis, operating income reached $1.7 billion, up 34% YoY, with operating margins of 25.2%, slightly below analyst expectations of 25.5%. These figures illustrate AMD's ability to drive operating leverage in its AI-focused businesses.
However, cash flow performance was a weak spot. Free cash flow (FCF) came in at $496 million, falling 58% below consensus estimates of $1.181 billion. This shortfall likely spooked investors, contributing to the stock's post-earnings decline. Nonetheless, AMD's balance sheet remains robust, with $4.5 billion in cash equivalents and short-term investments. The company also maintains a current ratio of nearly 2.5 and a low debt-to-assets ratio of 2.5%, reflecting solid financial health.
OutlookWall Street remains divided on AMD, with analysts revising earnings expectations downward while raising revenue projections. Although the Gaming and Embedded segments face headwinds, the AI PC refresh cycle and Data Center growth should support AMD's medium-term outlook. The Data Center segment is particularly critical in sustaining buying interest in the stock, as its growth potential aligns with long-term trends in AI and cloud computing. AMD's execution against Intel (NASDAQ:INTC) has been a key driver of its 300% total return over the past five years. However, competing with Nvidia in the AI space has proven more challenging, suggesting continued volatility for the stock. Still, with strong fundamentals and an expanding presence in the AI infrastructure market, I believe AMD remains a compelling investment for those willing to navigate near-term fluctuations in pursuit of long-term gains.
Valuation PerspectiveI remain highly optimistic about AMD's prospects for the coming year. The demand for AI chips is likely to remain strong, and any potential decline in interest rates could provide an additional tailwind. If rates were to drop from the current 5%+ levels to around 2.5%-3% over the next couple of years, it would likely sustain or even boost the valuations of major semiconductor companies.
AMD Data by GuruFocus
Currently, AMD trades at a forward P/E ratio of about 26x, which is below its 5-year historical average of 32x. By comparison, Nvidia's P/E ratio stands at around 34x, a reduction from the 50x-60x range it commanded during the height of the AI hype. Despite the drop, Nvidia remains in a league of its own, thanks to its exceptional revenue growth and gross margin expansion over the last two years. For AMD, the disparity in valuation stems from its slower pace of growth in AI-related revenues compared to Nvidia. However, AMD is just beginning to unlock its potential in the AI space. With expanding gross margins and the ability to generate consistent operating leverage and free cash flow, I believe a forward P/E multiple of 29x is realistic. Under this scenario, AMD's stock would be valued at approximately $150 per share, representing an 11% upside from current levels.
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From a discounted cash flow (DCF) perspective, the upside looks even more promising. Based on Wall Street estimates, a DCF model suggests an intrinsic value of $173 per share, which represents a potential upside of about 22%. This model uses a conservative discount rate of 9% and a terminal growth rate of 3%, aligned with GDP forecasts (very conservative assumption, especially beyond Year 5). Revenue projections in the DCF model forecast growth from $36 billion in Year 1 to $81 billion by Year 5, in line with Wall Street estimates. Additionally, operating margins are expected to expand significantly, rising from 21% in Year 1 to 35% by the end of the forecast period. While these assumptions may appear optimistic, they reflect the enormous growth potential in the AI and data center markets. As AMD solidifies its position in the AI space and benefits from macroeconomic tailwinds, I believe these targets are achievable, offering compelling upside at the stock's current valuation.
Concluding ThoughtsIn my view, AMD remains a compelling investment for those willing to navigate near-term fluctuations in pursuit of long-term gains. My thesis is rooted in AMD's dominant positioning in AI data centers, supported by a robust multi-generational product roadmap of GPUs and CPUs. These products offer customers a strong total cost of ownership (TCO) profile, ensuring AMD's continued relevance in a rapidly expanding AI market. With AI data center revenues projected to surpass $5 billion in 2024, driven by demand from large cloud providers, AMD is positioned pretty well to capture meaningful market share. Unlike Nvidia, whose high valuation multiples leave little room for error, AMD provides exposure to the AI growth narrative at a more reasonable price. Any progress AMD makes will likely be welcomed by the market, while Nvidia faces heightened expectations and potential downside from even minor missteps. For investors looking to balance growth potential and valuation, AMD offers a strategic opportunity to capitalize on AI data center demand. I believe this stock is a buy for long-term portfolios.
This content was originally published on Gurufocus.com
