Semiconductor company Advanced Micro Devices (AMD 2.37%) released preliminary earnings results on Friday, Oct. 8. While the company has done tremendously well under the leadership of CEO Lisa Su, the pre-earnings results may have left investors a little spooked. It is October, after all.
But the same-day 14% sell-off was likely overblown. While the amount of information that was released is limited, the known metrics -- coupled with broader macroeconomic conditions -- seem to underscore that initial market reactions were based more on emotion than on fundamental logic. A look at AMD's preliminary results, and some interviews from research analysts, should help. Let's dig in.
Don't judge a book by its cover
According to the company's press release, total revenue is expected to increase 29% year over year to $5.6 billion in the third quarter. While 29% annual growth is respectable, it's a far cry from the 55% growth in management's previous guidance.
AMD breaks its revenue down into four categories: data center, gaming, embedded, and client. While the company recognized meaningful growth from its data center, gaming, and embedded segments, the client business unit declined 40% from a year ago. Management attributed the drop in that segment to a weakening demand in the PC market.
Market strategists believe that the waning demand in PCs is simply a function of broader macroeconomic conditions such as inflation and supply chain challenges. While this may be a cause for concern in the near term, there's a case to be made that it should have been expected.
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Why is the PC market down?
A big part of AMD's business is its relationships with original equipment manufacturers (OEMs). Essentially, AMD partners with other technology companies in an effort to be an exclusive provider of certain specifications, such as chips for laptops. These relationships are important because the size and frequency of orders from OEMs effectively serves as a proxy for consumer demand.
In his June market report, Ranjit Atwal, a senior director at technology research company Gartner, wrote that "consumer PC demand is on pace to decline 13.1% in 2022 and will plummet much faster than business PC demand, which is expected to decline 7.2% year over year." This is an interesting paradigm. Atwal points at high inflation, geopolitical tensions in Europe, and lockdowns in Asia as reasons for supply chain disruptions and falling consumer demand.
In essence, as demand from consumers decreases, there is a ripple effect on OEMs, which begin to scale back purchase orders. This effect subsequently hurts AMD, leaving the company with built-up inventory levels and fewer end customers.
Don't miss the forest for the trees
Following the release of preliminary earnings, Bank of America analyst Vivek Arya pointed out that AMD is not the only semiconductor company to experience waning demand in the PC market; competitors like Intel have the same issue.
However, while other semiconductor companies are trying to navigate the same challenges, they may not all be facing them at the same time. Investors can find it difficult to pinpoint which company is best positioned, and when these hiccups will subside. Arya said that weakness in the PC market is priced into semiconductor stocks.
It's important to remember that AMD generated growth from its other three revenue streams. And as with its competitor Nvidia, AMD's data center business grew a staggering amount -- AMD's grew 45% year over year -- a signal that it is taking market share away from rivals. This should encourage investors: Even though the consumer PC market is strained, this is likely a short-term issue that will reverse once inflation and other economic and geopolitical issues ease. By contrast, the demand in data centers is likely to continue growing for years to come, as corporations of all sizes invest more capital into digital transformation and data analytics.
As a result, now could be an extremely compelling time for long-term investors to consider AMD stock. It's likely to be several more months before inflation levels revert back to historical norms; however, many of the negative factors that impact consumer demand, supply chains, and inventory levels are accounted for in the stock price. Those are leading it close to a bottom, making this an ideal time to buy.
