Advanced Micro Devices (AMD -2.94%) has been steadily gaining market share from market leader Intel (INTC 0.02%) across the board since the company launched the first chips based on its Zen architecture in 2017. A combination of solid products from AMD and missteps from Intel fueled AMD's unlikely comeback.

That streak of market share gains came to an end in the fourth quarter of 2020, according to data from Mercury Research as reported by the PC-focused website Tom's Hardware. While demand for AMD's processors remains strong, shortages allowed Intel to recapture some lost market share.

Category

AMD Market Share Q4 2020

AMD Market Share Q3 2020

Desktop PC

19.3%

20.1%

Notebook PC

19%

20.2%

Server

7.1%

6.6%

Total

21.7%

22.4%

Data source: Mercury Research via Tom's Hardware.

Intel has a key advantage

AMD relies on third-party foundries to manufacture its chips. The company used to make them itself, but it spun off its manufacturing operations more than a decade ago. That move allowed AMD to focus on chip design and freed it from having to pour vast amounts of capital into manufacturing.

AMD's use of Taiwan Semiconductor Manufacturing's top-tier process for its new chips, along with Intel's manufacturing struggles, helped AMD win back a bunch of market share over the past few years. AMD's latest Ryzen 5000 desktop processors finally beat Intel's chips on single-threaded performance, which is particularly important for PC gaming. That would have been unthinkable even a few years ago.

But relying on third-party foundries has a cost: AMD can only sell as many chips as it can get made, and capacity is tight. Auto manufacturers are warning that a chip shortage will force production cuts this year, and devices like game consoles are in short supply.

Getting new capacity up and running takes time, and there are many companies fighting for that capacity. Demand for AMD's chips is outstripping supply, and there's not much it can do about it.

A semiconductor chip.

Image source: Getty Images.

Intel doesn't have this problem. While the company has had difficulties with production over the past few years, particularly related to its troubled 10nm manufacturing process, Intel doing most of its own manufacturing means that the company doesn't face the same constraints as AMD. Intel was able to capture business that would have likely been won by AMD absent a chip shortage in the fourth quarter.

While Intel no longer has a manufacturing edge over third-party foundries in terms of technology or capabilities, doing its own manufacturing does give it an edge over rivals during times of tight third-party foundry capacity. AMD's chips are on par or better than Intel's chips at this point, but you can't sell what you can't make.

Intel still needs to get its act together on the manufacturing front. Capacity shortages won't last forever; neither will the pandemic-driven boom in demand for laptops and other devices. Market share gains for AMD will likely resume once the chip shortages ease.

AMD still had a strong fourth quarter despite losing share to Intel. Total revenue soared 53% thanks to shipments of game console chips, while the core computing and graphics segment produced 18% growth. However, the stock is priced for some serious growth. The company produced adjusted earnings per share of $1.29 last year, putting the price-to-earnings ratio at a frothy 68.

Chip shortages will make it difficult for AMD to grow fast enough in the near term to justify that sky-high valuation. That could put some pressure on the high-flying stock.