Advanced Micro Devices' (AMD 1.14%) stock fell nearly 5% during after-hours trading on Oct. 6 in response to a preview of its upcoming third-quarter earnings on Nov. 1. The chipmaker now expects its revenue to rise 29% year over year to $5.6 billion with an adjusted gross margin of 50%, compared to its prior forecast for about 55% growth with an adjusted gross margin of 54%.

CEO Lisa Su blamed that big miss on macroeconomic conditions, which "drove lower-than-expected PC demand and a significant inventory correction across the PC supply chain." The company expects its client (or PC) revenue to plunge 40% year over year to $1 billion, which will largely offset the growth of its data center, gaming, and embedded divisions.

A person uses a desktop PC.

Image source: Getty Images.

That was a disappointing update, but investors should have already curbed their expectations for the PC market following HP's disappointing third-quarter report in early September. Other chipmakers like Micron have also issued similar warnings.

AMD clearly overestimated its own ability to resist that cyclical downturn, but is its stock getting too cheap to ignore after declining more than 50% this year? 

How bad was AMD's slowdown?

In 2021, AMD's revenue grew 68% to $16.4 billion, its adjusted gross margin expanded 370 basis points to 48.3%, and its adjusted earnings per share (EPS) more than doubled. That growth was driven by robust sales of its Ryzen CPUs, Radeon GPUs, and Epyc CPUs for data centers. It benefited from elevated sales of consumer PCs as more people worked remotely, as well as market share gains against Intel (INTC -0.62%) across the PC market.

In the first half of 2022, AMD's revenue (which was boosted by its acquisition of Xilinx in February) surged 70% year over year to $12.4 billion, its adjusted gross margin expanded to 53.4%, and its adjusted EPS grew 90%. Therefore, its abrupt slowdown to just 29% revenue growth in the third quarter likely caught many investors by surprise.

What are AMD's main weaknesses?

Starting in the second quarter of 2022, AMD split its computing & graphics division and EESC (enterprise, embedded, and semi-custom) division into four new segments -- data center, client, gaming, and embedded -- to more clearly reflect its growth.

The biggest change was made to its EESC segment, which had housed its data center and custom APUs for gaming consoles. It shifted its data center chips into in a stand-alone segment, while its custom gaming console APUs joined AMD's Radeon GPUs in the gaming unit. The new embedded segment now mainly houses Xilinx's programmable chip business. Shifting its PC CPUs into the new client division also set up easier comparisons with Intel's client computing group.

AMD's year-over-year growth still looks strong, but it actually expects revenue to decline 15% sequentially in the third quarter as its tumbling client revenue and the flattish growth of its gaming segment overwhelm the single-digit growth of its data center and embedded businesses:

Division

Q3 2022 Revenue

QOQ Growth (Decline)

YOY Growth 

Data Center 

$1.6 billion

8%

45%

Client 

$1 billion

(53%)

(40%)

Gaming 

$1.6 billion

0%

14%

Embedded 

$1.3 billion

4%

1,549%

Total Revenue

$5.6 billion*

(15%)

29%

Data source: AMD. QOQ = quarter over quarter. YOY = year over year. * Column does not add up to total because of rounding.

Those sequential declines indicate AMD will likely face a tough cyclical slowdown over the next few quarters as it grapples with inflationary headwinds for discretionary spending, supply chain challenges, and tough comparisons to the temporary stay-at-home growth spurt for PCs throughout the pandemic.

According to market research firm IDC, global shipments of personal computing devices (PCs and tablets) could decline 10.8% this year and slip another 2.3% in 2023 before finally recovering in 2024. But IDC still expects those shipments to stay below pre-pandemic peaks through 2025. In other words, any company that is heavily dependent on the PC market should probably brace for at least two more years of sluggish growth.

Is AMD undervalued right now?

Analysts had originally expected AMD's revenue to rise 57% this year, 12% in 2023, and 13% in 2024. On the bottom line, they had expected its net income to increase 22% this year, 44% in 2023, and 26% in 2024.

Based on those estimates, AMD's stock looks cheap at 14 times forward earnings. Intel and Nvidia, which are both growing slower than AMD, trade at 10 and 29 times forward earnings, respectively. AMD's valuation might seem reasonable, but it's still pegged to earnings estimates that will likely need to be reduced to account for its latest update.

Therefore, I believe it's too early to consider AMD to be a screaming bargain. So investors should stick with more-balanced semiconductor plays like ASML Holding or Taiwan Semiconductor Manufacturing until they get a clearer picture of how long AMD's cyclical downturn will actually last.