Investors Reassess AMD Amid AI Chip Market Decline

The surge in generative artificial intelligence (AI) has flooded the tech sector with investment. However, investors are starting to choose their investments more carefully.

Despite its involvement in the growing AI market through data center hardware sales, shares of Advanced Micro Devices (NASDAQ: AMD) have dropped 32% since hitting an all-time high of $211 in March. Let’s evaluate whether AMD still has the capability to produce significant returns for investors over the long haul.

What’s Causing AMD’s Stock to Decline?

Determining the exact reasons for AMD’s stock drop is challenging, but valuation plays a major role. At its peak, shares commanded an astonishing 340 times trailing earnings, suggesting the market may have overestimated growth potential.

Currently, AMD’s trailing price-to-earnings (P/E) ratio stands at 126. While this is a decline, it remains significantly higher than Nvidia, which has a trailing P/E of 63, and nearly five times the S&P 500 average of 26. In comparison, AMD reported a modest 18% revenue growth, totaling $6.8 billion, with gross margin rising by only 3 points to 50%.

By contrast, Nvidia’s third-quarter earnings surged 122% to $30 billion with a gross margin increase of 5 points to 75%.

On a more positive note, AMD’s net income surged 191% year over year to $771 million for the same period. However, this increase was affected by volatile acquisition-related amortization costs, which may not recur. AMD’s management prefers to use adjusted net income, indicating a more subdued growth rate of 33%, bringing the figure to $1.5 billion.

One key factor distinguishing AMD from Nvidia is their different levels of exposure to the AI chip market, particularly through their data center segments. For AMD, about 51% of sales come from data centers, while this accounts for an impressive 88% of Nvidia’s sales. Furthermore, AMD’s sales from gaming hardware declined a staggering 69% in the third quarter, impacting overall results.

This situation may not be sustainable long-term, as underwhelming performance in AMD’s other sectors is making its data center segment a larger portion of total sales.

Image source: Getty Images.

Recently, AMD expanded its capabilities by acquiring ZT Systems for $4.9 billion. This company provides AI and general computing infrastructure targeted at cloud computing and data center clients. This acquisition could help AMD remain competitive in the rapidly evolving AI hardware sector. Additionally, AMD is launching new AI chips, such as the Instinct M1325X, set to compete with Nvidia’s upcoming Blackwell-based chips in 2025.

Is AMD Still a Pathway to Wealth?

Typically, when thinking about stocks that have the potential to create millionaires, I picture small, underestimated firms with impressive growth rates. AMD, however, doesn’t fit this mold, as its diversified business model prevents it from focusing solely on the AI chip sector. Additionally, competition from Nvidia and other companies limits AMD’s revenue and profit probabilities.

Nevertheless, after a substantial decrease in stock price this year, AMD appears to offer better value than previously. While investors shouldn’t expect remarkable returns soon, the stock shows potential for long-term growth supported by market trends. Waiting for a clearer market picture may be a wise move before investing in AMD.

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*Stock Advisor returns as of November 4, 2024

Will Ebiefung has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Advanced Micro Devices and Nvidia. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.