Artificial intelligence (AI) technology has taken the semiconductor world by storm, but the problem for Advanced Micro Devices (AMD 1.78%) is that rival Nvidia has run away with the opportunity so far. Nvidia stock has soared 214% this year, leaving AMD in the dust.
Can AMD mount a comeback? Its stock is already up 64% year to date, as Team Red prepares to launch new chips that could give Team Green a run for its money. Let's consider the bear and bull case for the stock.
Bear: Trailing Nvidia's lead
AMD has had no trouble delivering high growth in recent years, but one reason for investors to take a pass is that top competitor Nvidia seems to always be a step ahead of AMD.
Both companies compete head-to-head for gaming enthusiasts in the graphics processing unit (GPU) market, and Nvidia has controlled this market for many years. Nvidia has translated its innovation in GPU technology to the data center space, where it currently commands an estimated 80% to 95% of the market for AI chips.
Nvidia's history of innovation, large and growing cash resources, and plans to launch new generations of its high-powered data center chips over the next few years will make it difficult for AMD to out-innovate Nvidia.
Still, AMD is trying to catch up. Nvidia's main advantage is its investments in not only chip hardware, but software that helps customers get the most out of the chip's performance. To answer, AMD recently announced the acquisition of open-source AI software provider Nod.ai, which should strengthen AMD's position.
However, another issue for AMD is weak PC sales. Data center revenue only makes up a small portion of its revenue. Nearly half of AMD's revenue comes from its client segment, including sales for consumer desktop and notebooks and gaming GPUs. The client segment reported a 54% year-over-year drop in revenue last quarter, with gaming down 4%. This dragged AMD's top line down 18% over the year-ago quarter.
IDC reported another decline in PC shipments in the third quarter, so AMD may report another relatively weak quarter in its next earnings release. The good news is that the PC weakness is temporary and will eventually turn into a growth tailwind once the economic headwinds are past. Management is already anticipating a strong selling season for client processors in the second half of the year.
Bull: High interest in AMD's MI300 AI chip
One reason to buy the stock is AMD's upcoming MI300 chip, which is set to go into production in the fourth quarter. The chip's greater memory bandwidth will position AMD for growth in AI inferencing, which is how an AI model learns to make predictions using new data.
Nvidia leads the market for AI training, which is the initial phase of creating an AI model. However, inference will become a more important part of AI development going forward, and this could play to AMD's advantage in memory capacity.
The AMD Instinct MI300X GPU was designed with plenty of memory bandwidth to address the growing demand for large language model inference, which is the technology behind generative AI applications like OpenAI's ChatGPT.
Microsoft is expected to be AMD's largest customer for these new chips next year. The software giant's chief technology officer Kevin Scott recently said that AMD's GPU offerings look increasingly compelling, where its Instinct MI300X accelerator was specifically designed for AI models. AMD is touting the chip as the "world's most advanced accelerator for generative AI," and Microsoft seems to agree.
If Microsoft likes the value and performance of the MI300, it could lead to a windfall of more orders from other tech leaders. During a Goldman Sachs technology conference in September, AMD CEO Lisa Su mentioned there had been an acceleration in customer engagements in just the previous 30 days, adding, "A number of those engagements have now turned into customer commitments, which we're really excited about."
For what it's worth, Wall Street estimates have AMD reporting 20% revenue growth in 2024, with higher margins pushing earnings per share up over 50% year over year.
Is AMD stock a buy?
It's clear AMD should see its data center business grow into a larger percentage of total revenue over the next decade. These high-powered chips command steep prices, and along with that, highly profitable revenue. Starting next year, AMD should see its profit margin expand, which is a catalyst for strong earnings growth and a higher stock price.
Ahead of this opportunity, the stock's valuation looks relatively attractive. Shares of AMD trade at a price-to-sales ratio of 7.9 -- a deep discount to Nvidia's P/S multiple of 34. Considering Microsoft's endorsement, I believe AMD stock is worth buying before 2024 arrives.
