Advanced Micro Devices' (AMD -5.44%) latest results were met with mixed reactions. Though the chipmaker delivered terrific annual growth in its revenue and earnings, its guidance for the current quarter fell short of Wall Street's elevated expectations.
AMD expects first-quarter revenue of $1.8 billion, a jump of 42% from the prior-year period. But analysts were looking for $1.86 billion in revenue. This seems to have spooked investors slightly, as AMD shares fell after the results came out.
Now, that isn't entirely surprising given that AMD is trading at a rich trailing price-to-earnings (P/E) ratio of 184. The five-year earnings multiple for AMD stock is 137 times. So the company needs to meet the bar that the market sets, and any failure on that part could trigger panic among investors who might be eager to book profits considering the sky-high valuation.
This brings us to the question -- is AMD stock a risk worth taking at its current valuation? Let's find out.
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Can AMD justify its sky-high valuation?
The answer to this question tends to the positive side. Though AMD's first-quarter outlook was slightly lighter than consensus estimates, the full-year outlook was better than expected. AMD projects $8.7 billion in revenue in fiscal 2020, up 29% from the previous year and a shade higher than the $8.6 billion Wall Street estimate.
For comparison, AMD's top line increased just 4% annually in fiscal 2019, so 2020 is going to be a huge improvement if the company delivers on its promises. However, as Foolish colleague Timothy Green points out, AMD's first-quarter guidance wasn't that great, as the company's performance took a hit last year thanks to an oversupply in the graphics card market.
When compared with the first quarter of 2018, Green points out that AMD's revenue is on track to increase just 9% this time around. That's something that investors might be concerned about, considering the stock's rich valuation. But then, on a full-year basis, AMD's 2020 revenue could increase nearly 34% from 2018 levels when its top line stood at $6.48 billion.
So the bigger picture still seems to be in AMD's favor as it expects to deliver solid top-line growth for the full year. What's more, AMD projects a non-GAAP (adjusted) gross margin of 45% for the full year, higher than its 2019 non-GAAP gross margin of 43%. The combined effect of a nice bump in the company's revenue and an uptick in its margins is expected to drive solid bottom-line growth for AMD this year.
According to analyst estimates compiled by Yahoo! Finance, AMD's adjusted earnings could jump to $1.15 per share in 2020. That would be a huge jump over last year's non-GAAP earnings of $0.64 per share, and that's why AMD stock is trading at a much more reasonable 49 times forward earnings.
So buying AMD stock at current levels might not be a bad idea despite its expensive valuation. The company looks all set to step on the gas from a financial perspective this year, and that could justify the rich P/E levels.
Why AMD can deliver on its promises
AMD is counting on strength across its key product lines -- Ryzen, EPYC, and Radeon -- to achieve growth this year.
The company's Ryzen CPUs (central processing units) have been in strong demand, as evident from the fact that they have been taking market share away from Intel (INTC -2.40%). Mercury Research recently reported that AMD's market share of CPUs jumped to a five-year high of 18.3% at the end of the fourth quarter of 2019. That was an increase of 2.4 percentage points over the prior-year period.
It won't be surprising to see AMD gain more market share over Intel in the CPU space this year thanks to the latter's production bottlenecks and a delay in Chipzilla's technology upgrade. The CPU shortages at Intel have turned out to be a blessing in disguise for AMD. The latter could continue to enjoy an advantage over its bigger rival through the second half of 2020, as that's when Intel expects its CPU inventories to reach normalized levels.
Meanwhile, AMD has also gained on Intel in the market for server processors, per Mercury Research. The company held a 4.5% share of the server market at the end of the fourth quarter of 2019, an increase of 1.4 percentage points over the prior-year period.
Now that AMD has managed to create a niche for itself in both these key markets, it can work on boosting its share this year with new launches in the cards. For instance, AMD is looking to go after Intel's laptop market share with its Ryzen 4000 chips. The company claims that its latest chips are more capable than their Intel counterparts, and more than 100 devices based on the Ryzen 4000 platform will be launched this year.
And finally, AMD can count on a new catalyst this year in the semi-custom business -- gaming consoles. Sony and Microsoft are on track to launch their next-generation consoles this year, and AMD stands to gain from their moves as it will be supplying its chips to power them.
In all, AMD is sitting on what seems like a favorable business environment for the remainder of the year that should help it achieve its lofty growth targets. That's why investors looking for a top growth stock should continue holding AMD as its rally seems likely to continue.
