Investors with a preference for tech stocks have a lot of choices these days. Technological revolutions seem to lurk around every corner, and for every explosive new market or opportunity, there are several companies poised to compete. According to Finviz.com, there are more than 500 stocks in the tech sector today, not counting 250 micro-cap penny stocks.
Amid such a plethora of investment choices, and with such a change-prone industry, it can be harder than usual to distinguish the companies on track to be long-term winners from those more likely to become failing wannabes. As an example, let me walk you through the investing cases for and against embedded chip specialist Cypress Semiconductor (NASDAQ:CY) and graphics-plus-CPU veteran Advanced Micro Devices (NASDAQ:AMD).
Both of these companies work in the chip sector, but they rarely compete head-to-head.
Cypress is aiming at three key markets these days. The company designs low-power wireless networking chips for Internet of Things devices, next-generation USB-C controllers for tablets and smartphones, and a variety of embedded solutions for the automotive computing sector. These target markets overlap in some cases. For example, car companies have started to adopt USB-C connectors to enable faster connections between the electronic subsystems of modern vehicles. The world's eight largest automakers have all included Cypress chips in their in-car Wi-Fi and Bluetooth solutions, and that segment now accounts for 31% of Cypress' quarterly revenues overall. That's up from just 12% five years ago.
By contrast, AMD's core market is in central processors and graphics chips for the PC market. The graphics products are sold under the Radeon brand, while processor names include Ryzen, Threadripper, EPYC, Athlon, and the A series of system chips with included graphics functions. The company also makes semi-custom processors for gaming consoles and embedded systems. As it turns out, modern graphics processors are good at the kind of math and data handling that's necessary for mining Ethereum and other cryptocurrencies. So crypto-mining has been a growth driver for AMD in recent quarters, and the same functionality also gives AMD's graphics chips a number-crunching place in data centers.
I would say that both Cypress and AMD are striving for results in strong end markets, with plenty of growth potential in the years ahead. However, I would argue that the automotive and USB-C targets hold more promise than the potentially faddish cryptocurrency market. Moreover, the PC sector has been suffering for years now, and AMD faces tremendous competition in every part of the data center market. All in all, the business story behind Cypress just makes more sense.
AMD is not a profitable company. The chip designer has reported negative earnings, cash flows, and EBITDA profits for years. And even though AMD's top-line sales are improving, profits have not followed suit.
Cypress, on the other hand, matches its solid earnings with strongly positive cash flows and EBITDA tallies. In particular, the company is increasing its cash generation these days.
In other words, AMD is still struggling to achieve a turnaround while Cypress can coast on a steady platform of stable cash profits. Moreover, Cypress sports positive profit trends while AMD's bottom-line trend lines are stalling. This one's a no-brainer:
Market performance and valuation
AMD investors enjoyed a strong second half of 2016, followed by a less impressive share-price chart in 2017. That adds up to a 119% gain over the last 52 weeks but just a 17% return year-to-date.
Cypress is running the short-term race on a different track. The stock has gained 27% year-to-date but only 22% over the last full year.
It's hard to complain about massive market gains, but AMD's stock may be due for a correction. The company's valuation is difficult to pin down, thanks to negative results of every kind. Looking at analysts' forecasts for the next fiscal year, you still get a nosebleed valuation of 42 times forward earnings. Cypress investors can breathe much easier as their holdings measure up at just 13 times forward earnings or 23 times trailing earnings.
Market momentum is not a sustainable advantage. I would much rather own Cypress at these prices.
That's a clean sweep as Cypress takes all three rounds. Honestly, it's a stock I might consider owning today, while AMD moved out of that category last summer.