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Why Should Long-Term Investors Look at AMD’s PE Ratio?

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AMD’s price ratios

Advanced Micro Devices (AMD) reported a turnaround in its earnings from losses to profits in 2017, adding $1 billion to its revenue. Despite these impressive earnings, AMD stock fell 9.4% in 2017. It’s risen 14% since the start of 2018, underperforming NVIDIA (NVDA), which has risen 24.8% YTD (year-to-date).

AMD’s financial growth isn’t reflected in its stock because the stock is highly valued. The most popular measure by which to value a stock on fundamental grounds is its PE (price-to-earnings) ratio. A PE ratio tells us the amount investors are willing to pay per dollar of EPS (earnings per share).

 A10_Semiconductors_AMD NVDA INTC PE ratio

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Price-to-earnings ratio

AMD has recently turned from a loss per share to a profit per share, reporting non-GAAP (generally accepted accounting principles) EPS of $0.17 in 2017. At such low EPS, it has a PE ratio in the hundreds. If we take analysts’ EPS estimate for 2018 into consideration, AMD’s PE ratio stands at 30.3x, which is higher again than Intel’s (INTC) PE of 13x and the S&P 500’s average of 19.9x. NVIDIA has a 2018 PE of 38.5x, but its earnings are high.

Even if we consider forward PE, which takes analysts’ EPS estimate for 2019 into account, AMD’s PE comes in at 22x. This shows that AMD stock had already priced in a significant amount of earnings when it rallied 300% in 2016. Hence, even if AMD reports strong earnings in 2018, it doesn’t mean that the stock price will increase significantly.

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Interpreting EPS growth and PE ratio

If we look at AMD’s profits, it turned EPS of -$0.14 in 2016 into EPS of $0.17 in 2017. It’s expected to increase its profit by another 100% or more in 2018. Its non-GAAP operating margin expanded from 1% in 2016 to nearly 6% in 2017, and it expects this margin to expand to 8% in 2018. The company’s profit growth is slowing.

Even if AMD succeeds in achieving its target EPS of $0.75 in the long term, the stock’s fair valuation will come out to $15 considering its PE ratio of 20x.

What should investors do?

AMD’s fundamental valuation shows that it’s an expensive stock and holds little upside potential at its current trading price of $12. However, this doesn’t mean that the stock will fall or that investors should sell. It does, however, indicate that at its current price point, AMD is not a good buy for long-term investors looking for cheaper stocks with strong growth potential.

Apart from earnings, long-term investors should also look at the financial health of the company and its ability to sustain short-term headwinds. We’ll take a look at this next.

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