Advanced Micro Devices (AMD, Financial) was almost flat in 2015, but the company has performed well this year. The stock is up over 230% year to date. The company faced many problems last year because NVIDIA (NVDA, Financial) crushed its GPU business and its CPU business was hurt by Intel (INTC, Financial).
However, the company has successfully turned around this year on the back of its new GPU architecture, Polaris. Moreover, the strong demand for gaming consoles -- Xbox One and PS4- allowed the company to move upward, as chips manufactured by Advanced Micro Devices were used in both consoles.
Sturdy sales of those consoles helped the company to achieve 8% yearly sales growth throughout the second quarter, which accounted for the first quarter of positive year-over-year growth in the past two years. However, taking a deeper look at the financials reveals a completely different story.
The company earnings and revenue are declining. Moreover, its gross margin has reached 22%, a drop of 15% compared to the same period three years ago. In comparison, NVIDIA’s financial performance looks much better as its revenue is growing at a rapid pace. NVIDIA’s margin also escalated from 54% to 59%.
Considering this, it seems like Advanced Micro Devices will never return to profitability since its gross margins are less than 30% due to research and development costs. The company spent less than $1 billion per year on research and development, as it previously cut R&D outlays to a minimum. That figure is substantially lower than NVIDIA’s spending on research and development.
The company’s restricted spending on R&D was the primary reason behind the defects found in the initial version of RX 480, a Polaris-based graphics card. Furthermore, it is still not clear what steps the company will take when it requires cash at the end of next year.
Apart from this, the company is on its way to launch its new Zen architecture, designed specifically for CPUs. However, Intel’s new processors are also about to launch and will compete directly with Zen-based processors. Advanced Micro Devices' future prospects heavily depend on its Zen architecture. However, investors should remember that Intel is a comparatively larger and highly stable business compared to AMD.
Conclusion
Currently, Advanced Micro Devices trades at $9.56 per share, a surge of over 400% from its all-time low, but it still faces tough competition from NVIDIA and Intel. At the time of Polaris' launch, the company’s strategy of capturing the low end of the graphics card market reaped fruitful results for the company. However, that move forced them to hand the lucrative high-end of the graphics card market to NVIDIA.
Research and development plays a very significant role in technology. NVIDIA has large cash resources that allow it to spend freely on R&D. The same does not apply to Advanced Micro Devices. The stock has surged considerably this year and now is the best time for investors to book a profit and avoid the stock.
Disclosure: I do not hold positions in the stocks mentioned in the article.
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