It Looks Like AMD Stock Has Reached Its Peak

After an underwhelming 2017, chipmaker Advanced Micro Devices (NASDAQ: AMD ) has turned in one of the hottest performances thus far in 2018. Year to date, AMD stock is up nearly 60%, with most of that gain coming in the past three months.

What has been the big driver of AMD stock’s 60% year-to-date rally?

A few things.

Blowout first-quarter earnings kicked things off at the end of April. AMD reported a double-beat-and-raise quarter, which illustrated continued robust growth in high-end cloud computing markets, a market historically dominated by competitors NVIDIA (NASDAQ: NVDA ) and Intel (NASDAQ: INTC ).

AMD stock went from under $10 to over $11 the day after those earnings. The stock hasn’t looked back since, mostly because the consensus among market insiders, investors, and analysts is that AMD will continue to steal market share from peers at an accelerated pace in the back-half of 2018. Consequently, AMD stock now trades north of $16.

But AMD stock has also been stuck in neutral for the past month. To some, that may imply that this stock has peaked and could fall in a big way on any bad news. Is this true? Has AMD stock peaked?

I think so. Fundamentals and technicals both point to AMD stock being ahead of itself at this point. As a result, with second quarter earnings right around the corner, I’m a little bit worried about what’s in store for AMD stock.

Here’s a deeper look.

Fundamentals Imply That AMD Stock Is Overvalued

I have long maintained the view that fair value on AMD stock is in the mid-teens range.

At the current moment, the broad consensus on AMD is that demand for the company’s PC and gaming chips remains robust, while market-share gains in DC and AI should persist, thanks to new products like Epyc. Meanwhile, downside risk from a demand collapse in cryptocurrency mining is mitigated relative to the upside potential.

Thus, reward potential is large and risk potential is small. That has driven AMD stock to above $16.

But, in the bigger picture, this isn’t a huge growth company. Big growth is coming from market-share gains in DC and AI. Those gains should moderate, as AMD more consistently and intrusively rubs elbows with the big players in the space. Thus, today’s 40% revenue growth is not sustainable.

In the long-term, revenue growth should run around 15% per year, as robust end-market demand tailwinds are partially offset by increased competition headwinds. During that stretch, I have utmost faith that AMD can reach its long-term margin targets of about 42% gross margins and about a 28% OPEX rate, implying operating margins in the long run of 14%. Under those assumptions, I think it is reasonable to assume AMD nets earnings per share of roughly $1.10 in five years.

A market-average growth multiple of 20 on forward earnings of $1.10 implies a four-year forward price target of $22. Discounted back by 10% per year, that equates to a year-end price target of ~$16.50 — right where the stock currently trades.

Technicals Imply That AMD Has Come Too Far, Too Fast

From a technical perspective, AMD stock doesn’t look that great either.

This is a stock that went from under $10 to above $17 in a hurry after first quarter earnings. Since, AMD stock has cooled off. It dipped back to $15, and then rallied again. But that rally ended before $17. Thus, the stock is making lower highs, and that is often a sign of a stock that is going from uptrend to downtrend.

Moreover, this isn’t a stock that heads upwards in linear fashion like NVDA. Instead, AMD is historically prone to bunches of volatility. Go look at the chart. Big rallies are followed by big sell-offs, which are followed by big rallies — so on and so forth.

There really isn’t any reason to believe that this time is different.

The Set-Up Into Earnings Isn’t Favorable

Second quarter earnings are due after the bell on Wednesday, July 25.

The last earnings report was a blowout one. And AMD stock jumped on those results. There are reasons to believe that AMD’s numbers will be just as good this quarter considering demand tailwinds in AI and DC are just as strong today as they were three months ago.

But AMD stock popped in a big way on those numbers because the stock was sitting below $10. Now, though, the stock is sitting above $16. Clearly, the expectations are way bigger. I find it hard to believe that AMD, given potential headwinds from the trade war and more competition, lives up to those super-charged expectations with its Q2 report.

Bottom Line on AMD Stock

AMD stock was a great buy below $10. But above $16 and on the heels of a 60% trailing three-month rally, AMD stock looks less compelling.

Indeed, I think this stock put in a near-to-medium peak at $17 and that further downside is likely following Q2 results.

As of this writing, Luke Lango was long INTC.