There is no question that technology companies in particular experienced unprecedented demand during the peak of the coronavirus pandemic. However, a mixture of overhiring and tighter corporate budgets resulted in immense cost-cutting efforts and cloudy financial guidance from management teams.
Underneath the broader technology umbrella lies the semiconductor landscape, which has experienced its fair share of challenges over the last couple of years. From supply chain disruptions to waning consumer demand, the goods and services produced by chip companies certainly face an uphill battle.
Advanced Micro Devices (AMD 1.56%) recently reported earnings for Q1 2023. Despite declining revenue and deteriorating margins, the stock has been moving higher since the earnings report in early May. Let's dig into Q1 and determine if AMD deserves a spot in your portfolio.
How did the company perform in Q1?
For the quarter ended April 1, 2023, AMD reported $5.4 billion in total revenue, which represented a 9% decline year over year. The primary culprit behind the shrinking revenue base came from the company's client revenue segment, which includes consumer hardware devices like processing units and chips. The segment was down a whopping 65% year over year.
On the surface, it may look alarming that a semiconductor company is seeing a major decline in demand for its core hardware. However, AMD's CEO, Lisa Su, warned investors about headwinds in its client business during the Q4 2022 earnings call. Moreover, she stated during the Q1 call that she believes Q1 is the bottom for the company's client processor unit (CPU) business, which sits under the broader client revenue segment.
The three other segments that AMD reports revenue for are data center, gaming, and embedded. Data center revenue was flat year over year, while gaming was down a nominal 6%. The company's embedded revenue segment generated $1.6 billion in revenue during Q1, which represented annual growth of over 160%. Per the company's earnings transcript, AMD released some new products and capabilities in its embedded business, including those that leverage artificial intelligence (AI).
Demand for products that leverage AI is increasing. Big tech has dominated headlines over the last several months as investments in AI rise. Chip companies like AMD will play an integral role in the evolution of AI, and Q1 illustrates that.
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Why is the stock moving higher?
Revenue was not the only metric that was down in Q1. AMD's gross margin declined from 48% in Q1 2022 to 44% in Q1 2023. Furthermore, the company's Q2 and full-year guidance for 2023 was disappointing. Revenue is expected to keep dropping, which could hurt cash flow and the company's financial health. For these reasons, it's hard to understand why the stock is up over 20% since its earnings report about two weeks ago.
I have written a lot about the concept of momentum trading. Sometimes a stock will experience an influx of buyers that pushes its price to levels incongruent with its fundamentals. While momentum trading is not exactly the same as meme investing, there are some commonalities.
For AMD, the bear case is pretty obvious. The personal computing market is experiencing a dramatic slowdown in consumer demand. As a result, other business units, such as gaming and data centers, feel the repercussions. In essence, the picture doesn't look that great for AMD.
Why is the stock a buy?
While the bear case is clear, AMD's bull case is more complicated. One interesting takeaway from Q1 was how well the company's embedded segment performed.
Over the last several months, market leaders like Alphabet and Microsoft have been compelled to invest aggressively in AI. It seems to have more potential, particularly in the short term, than the metaverse. During Q1 earnings, companies across the board told investors about products that have already been released in the last few months the leverage generative AI. Artificial intelligence is already here, while practical applications for the metaverse are years down the road.
This could be a huge catalyst for AMD. While Q1's embedded revenue results were encouraging, investors should be keenly analyzing the remainder of 2023 and how the company's AI efforts are progressing.
To me, AMD seems to be stuck between a rock and a hard place. As long as the economic picture remains cloudy, the company's business likely won't thrive. However, factors such as inflation and recession eventually dissipate. Bear markets don't last forever.
While I don't recommend buying a stock on an upswing, I've often referenced the old adage that time in the market is more important than timing the market. AMD has some meaningful catalysts, namely AI, that are yet to be priced into the stock. A prudent action for investors could be to dollar-cost average into the stock over time.
