What happened

Shares of Advanced Micro Devices (NASDAQ:AMD) slumped on Wednesday following the release of the chip company's third-quarter earnings report. AMD managed to beat analyst expectations across the board and raise its full-year revenue guidance, but that wasn't enough to satisfy the inflated expectations built into the stock price. As of 11:56 a.m. EDT, shares of AMD were down 11.6%.

So what

AMD reported third-quarter revenue of $1.64 billion, up 26% year over year and $130 million above the average analyst estimate. Growth was driven by the computing and graphics segment, which produced $819 million of revenue, good for 74% year-over-year growth. AMD has launched a full slate of new products this year, including Ryzen PC CPUs and high-end Vega GPUs, and those products are pushing revenue higher.

The AMD logo on a red background.

Image source: AMD.

Non-GAAP EPS came in at $0.10, up from $0.03 in the prior-year period and $0.02 better than analysts were expecting. AMD also managed to produce a GAAP profit of $0.07 per share, up from a loss of $0.50 per share in the year-ago period. AMD benefited from a patent licensing transaction during the quarter, but the details were not disclosed in the company's earnings press release.

AMD sees revenue growing by 26% year over year during the fourth quarter, with full-year revenue expanding by more than 20%. That's up from previous guidance calling for a mid- to high-teens full-year revenue growth rate.

Despite what looks like a great quarter for AMD, the market responded negatively. AMD shares have soared over the past two years, quadrupling in 2016 alone, and the stock was priced for perfection prior to the earnings report. AMD's results and guidance simply weren't enough to justify the stock price.

Now what

AMD is competitive in the PC CPU market with Ryzen, and its EPYC server CPUs should lead to at least some market share gains in the coming years. Those tailwinds will be partially offset by declining revenue from game console chips as those consoles enter the later stages of the cycle and the potential for GPU demand from cryptocurrency miners to collapse.

Even after Wednesday's drop, AMD stock trades for nearly 17 times what the company hopes to earn on a non-GAAP basis in 2020. A successful turnaround is still fully priced into the stock, so investors should brace themselves for more declines if AMD fails to live up to expectations.

Timothy Green has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.