Oct 10 2021 - AMD: Prepare For A Selloff

Summary

• AMD is the shining star of the semiconductor sector from many fundamental viewpoints.
• Every victory for AMD is a setback for Intel; the converse is also true.
• AMD is 100% to 229% overpriced relative to the market, depending on whether you account for its tax benefits.
• October has consistently been a losing month for AMD.
• Profit from (or protect your holdings from) the statistically likely pullback via a bear ratio spread.

Scott Olson/Getty Images News

I last wrote about Advanced Micro Devices (AMD) back in April, when the stock was trading in the s. I was highly bullish on AMD, in part due to the Xilinx acquisition and in part due to being bearish on Intel (INTC). As many AMD investors know, the competition between AMD and Intel is fierce – and much of the chip game is a race to eat up competitors’ market shares.

As AMD is up 30% since my last article, I was recently asked whether AMD is still a buy, here at 0+ per share. Today, I want to answer that question. (I was also asked if INTC is still a short, it having fallen 20% since my short call – I’ll get to that question later this month.)

The Long Game

I wanted to begin with a TLDR answer to the question as to AMD is a buy at this price, but the answer is not so simple. As you’ll see later, I believe AMD is overpriced here, but only from a short-term perspective. If you have a long-term time horizon, AMD should look cheap now, in retrospect.

If you were to evaluate AMD via a fundamental perspective, with emphasis on its metrics’ trends, you’d see performance that will inevitably justify the 0+ valuation of the stock in the near future. Over the last two years, AMD has nearly tripled its revenue, improved its profit margin from single digits to 25%, and raised its GAAP net income from 1M to .4B – all while doubling its R&D expenses. That last part is important because increased R&D expenses have been shown to deliver a premium in the stock; as long as R&D is growing alongside income as well as revenue, the stock should continue upward as well, and short-term overboughtness will in the long-term appear relatively cheap.

AMD has also been consistently outpacing the industry in its earnings growth.

(Source: Simply Wall St., with permission)

This is possible because of AMD eating into Intel’s market share. And AMD need not conquer the whole market. The fact that AMD is fabless gives it an edge over Intel: The more of Intel’s market share AMD nibbles at, the more difficult it becomes for Intel to gain excess profits via economies of scale. Intel relies on volume to benefit from its fabs, as fabs come with high fixed costs. Thus, AMD’s revenue and earnings have an inverse relationship with Intel’s, and with AMD’s on the upswing, Intel’s is naturally on the downswing, as seen below.

(Source: Simply Wall St., with permission)

While it is possible for Intel to stage a comeback, which would put downward pressure on AMD’s revenue and earnings, thereby also hindering the stock’s momentum, at present AMD has momentum on its side. I believe this momentum will last as long as AMD has the technical edge over Intel.

The Short Game

While the macros, market trends, and fundamentals backing AMD are all strong, the stock price has gotten ahead of the story. Again, 0 AMD will inevitably look cheap in the future, but for now, the stock price is overclocked, so to speak. While EPS has grown to an amazing extent the past few years, jumping from .75 to .85, the stock is nonetheless trading at 36.6x price-to-earnings, which is 100% higher than the market average.

(Source: Simply Wall St., with permission)

In addition, EPS is inflated in the short term due to AMD having taken a .3B tax benefit. Specifically, this tax benefit has inflated the EPS by 169%. Without this tax benefit, the price-to-earnings rises to 58.6x, or 229% higher than the market average.

The problem here is with valuation, not the stock itself. It’s an opportunity cost issue: You can pay 200% more for this company or buy a general market ETF. Or you could buy a sector ETF, tracking semiconductors.

The latter option comes with fewer risks than buying AMD. For one, stocks usually mean-revert, both against their own gains and against their fundamentals. AMD is overdue for such mean reversion.

Second, AMD investors are negatively exposed to the risk of good news from AMD’s competitors. A new offering or strong performance from Intel’s CPUs or Nvidia’s (NVDA) GPUs could send shockwaves across the sector, negatively impacting AMD’s stock price. A sector ETF is likely to see gains in such a case.

Third, AMD is highly exposed to market risk. It has a beta of 2.0, and so holding AMD exposes you to double the volatility of the general market. Intel, in contrast, has a beta of roughly 0.5, and is thus the less risky chip stock despite being the weaker company from a growth perspective.

Over the past two months, AMD investors have not been rewarded for taking on such risk.

Seasonality

During my analysis of AMD, I came across something curious. October has been an awful month for AMD investors. Over the past fifteen years, while holding AMD would have led to a cumulative return of 220%, holding AMD over October would have led to an astonishing 83% loss!

(Source: Damon Verial; data from Tiingo)

When I saw this result, I thought perhaps the result was overly influenced by AMD’s downward trajectory in the 2000s. However, when I restricted the backtest to AMD’s rally over the past five years, the results were still extremely bearish. While the stock rallied over 3500% since 2016, holding over October showed losses to the tune of 50%:

(Source: Damon Verial; data from Tiingo)

Such strength in seasonal patterns is rare. In my experience, such a signal is an opportunity for large profits.

The Trade

I believe over the course of my many articles on AMD, I have made it clear that I am highly bullish on this company. That said, given the price of the stock relative to the fundamentals, mean reversion, downside risk, and strong seasonality, I believe a short position on AMD is warranted. AMD should pull back over October, and we can dip-buy back into a long-term long position on the stock.

Bear ratio spreads make sense here:

1. Buy 1x Oct29 5 put
2. Sell 3x Oct29 puts

At the time of writing (Oct6), the price of this spread is exactly . Thus it is a free spread, giving you no potential upside risk and thus works also for investors who do not wish to sell their current AMD holdings. I chose this particular spread due to the prices allowing for a free credit spread and for the strike price being close to the 100-day moving average of .5, a price that should act as a short-term support level.

Anywhere between and 5 is profit region. The risk is a sudden downward selloff pushing AMD to below , at which point you will lose 0 for every movement below . You can evade this situation so long as you exit your position before AMD falls below . The ideal situation is AMD hitting exactly by the end of October, in which case you would have made 0 on your investment.