The NASDAQ composite index has fallen more than 22% since the start of the year. And such large market corrections have created plenty of opportunities to buy high-growth stocks at an attractive valuation.
Advanced micro-systems (NASDAQ: AMD) is a high-growth company whose price is now considered a value investment. AMD prices have fallen 33% since the start of the year. At the current assessment, all of its negative scenarios have been fully incorporated. Moreover, AMD’s true economic or owners’ profits have always been better than its accounting profits. You will see that its valuation is even more attractive than on the surface, by around 30% based on a Greenwald analysis to be adjusted for growth CAPEX.
Positive scenarios, on the other hand, have been downplayed or even ignored. Key near-term catalysts include Xilinx synergies and further margin expansions. Xilinx not only provided immediate financial benefits (adding $559 million in revenue within six weeks of acquisition), but also huge long-term opportunities to expand its addressable market. On a non-GAAP basis, its margin increased to a record 53%. AMD now has a strong product portfolio, which will almost certainly increase margin over the next few quarters by shifting its product line to higher-margin offerings like EPYC, Radeon, and Ryzen.
AMD Accounting EPS and Owner Revenues
The commonly quoted PE for AMD is based on GAAP accounting earnings. And at the time of this writing, it ranges between 19x and 37x depending on which report you’re reading (e.g. Yahoo Finance or Seeking Alpha) and what EPS baseline you’re using (annual, TTM, FW, et al. ). Apart from the variance, such a commonly quoted PE does not reflect its true economic earning power. And in AMD’s case, accounting profits underestimate its true earning power by a considerable margin.
You can already see the difference just by looking at the free cash flow (“FCF”) and EPS comparison shown in the following table. The chart shows accounting EPS per share and FCF per share for AMD over the past few quarters. You can see that its FCF has been consistently higher than EPS (ie, and the FCF-to-earnings conversion ratio has been consistently greater than 1).
In the next section, we will see that even the FCF already underestimates the true income of the owners because ALL CAPEX expenses have been considered as a cost in the calculation of the FCF.
AMD growth CAPEX and owner revenue
The key to understanding EO is to distinguish between growth and maintenance CAPEX. Growth CAPEX is optional and should not be considered a cost. For decades, investors like Warren Buffett have promoted this concept. The following quote from Buffett best describes it (emphasis added):
These represent (“a”) reported earnings plus (“b”) depreciation, depletion, amortization and certain other non-cash charges…less (“c”) the average annual amount of capitalized expenses for installations and equipment, etc. . the company needs to fully maintain its long-term competitive position and unit volume… Our The owner-profit equation does not yield the deceptively precise numbers provided by GAAP, since (“c”) must be a guess – and sometimes very difficult to make. Despite this problem, we consider the owner’s earnings figure, not the GAAP figure, to be the relevant element for valuation purposes… All of this underscores the absurdity of the “cash flow” figures which are often stated in Wall Street reports. . These numbers usually include (“a”) plus (“b”) – but do not subtract (“c”).
However, estimation (“c”) is indeed difficult and involves a more advanced understanding and analysis of financial statements. The basic concepts and steps are detailed in my previous article on AAPL. And in this article, I analyzed (“c”) for AMD using Bruce Greenwald’s method (detailed in my previous article or Greenwald’s book called Value Investing).
Against this backdrop, the following chart shows AMD’s true economic earnings versus its book EPS and FCF over the past few quarters. This analysis was performed using Bruce Greenwald’s approach. To determine the ratio of PPE (property, plant and equipment) to sales ratio, I used a five-year moving average. Some key observations from this graph,
- AMD’s OE is significantly superior to both its FCF and EPS. As an example, it reported EPS of around $0.4 per share last quarter and FCF of around $0.65 per share. However, its EO is around $0.85 per share, around 30% higher than its FCF and more than 2x its accounting EPS.
- The reason its OE is significantly superior to EPS and FCF is that most of AMD’s CAPEX is for growth, not maintenance. To me, that’s a sign of a high-growth compounder. This shows that AMD can employ large amounts of additional capital to pursue new growth opportunities, which will be elaborated on later.
Valuation is low and growth even cheaper
The following chart compares AMD’s current valuation to its historical valuation as well as overall market valuations. At its current price, AMD’s valuation is around 19.2x PE based on its FW accounting EPS, already below its historical average and also below the NASDAQ 100 index. The NASDAQ index is valued at around 33.8x PE when represented by the QQQ fund (based on Yahoo Finance data). So, in relative terms, AMD represents almost half of the valuation of the NASDAQ 100 index (56% to be precise). In terms of owner PE, its valuation is even lower based on the discussion above. It is only about 17.6x.
In terms of growth, the discount is even greater. As you can see from the following graph, the current PEG ratio for AMD is only around 0.31x. If we assume that the overall stock market has an annual growth rate of 10% (a generous assumption), then the current PEG ratio for the NASDAQ 100 index would be around 3.38x, more than 10 times higher than AMD. AMD’s growth is too heavily discounted to ignore.
Other growth catalysts
There are other growth catalysts that the market has yet to price in, creating more potential for AMD earnings growth and margin expansion.
The first catalyst concerns the acquisition of Xilinx. AMD’s acquisition of Xilinx was completed on February 14, 2022. Xilinx provides AMD with many long-term, high-margin revenue streams in a new set of markets. The acquisition of Xilinx not only produced immediate economic benefits (it added $559 million in revenue for the six weeks following the closing of the acquisition), but also created huge long-term opportunities for AMD to expand its addressable market, such as Versal HBM, FPGA-as-a-Service, 5G adaptive SOCs, and also more futuristic AI technologies.
The second catalyst involves further margin expansion. As you can see in the following chart, its margin increased to 50% in the last quarter of 2021, then to a record 53% in the last quarter on a non-GAAP basis. As mentioned above, if earnings are interpreted more correctly to adjust for growth CAPEX investments, its margin will already be considerably higher. AMD currently enjoys a strong product lineup, which is very likely to push the margin even higher in the coming quarters. The Enterprise, Embedded and Semi-Custom segment has more than doubled its volumes in recent quarters. It’s also been hugely successful, shifting its product line to higher-margin offerings, like the EPYC, Radeon, and Ryzen lines.
Final thoughts and risks
AMD is currently a high growth stock rated as a value stock. Its valuation is further distorted by its strong investment in growth CAPEX. With a PEG ratio of less than 1/10 of the overall market, it is almost considered a permanently stagnant stock. All of its negative scenarios were fully priced in, and the positive scenarios were discounted or even discarded. The major near-term catalysts, Xilinx synergies and further margin expansions are creating very favorable and asymmetric risk/reward profiles.
Finally, investing in AMD involves both short-term and long-term risks. In the short term, AMD faces a risk of a renormalization of market demand. In the post-COVID market, demand for PCs is declining and could dampen demand for AMD chips. Individuals are adapting their work habits amid the COVID outbreak and increasing demand for PCs. Today, global PC demand is showing symptoms of renormalization. In addition, over the long term, AMD faces competition and pricing power risks. AMD is constantly competing with other companies (such as Intel (INTC), NVIDIA (NVDA), QUALCOMM (QCOM), et al) in the chip space to create smaller, faster, and cheaper products. The competition may yet extend to other areas such as manufacturing and its console business.