Were These Earnings as Bad as Advertised?
Advanced Micro Devices traded considerably lower after reporting earnings on Friday. However, the company showed significant progress in many areas, and given its valuation, Advanced Micro might not be that bad of an investment.
What created the weakness?
Advanced Micro closed on Friday down almost 14% after reporting earnings . Surprisingly, the quarter was pretty solid. The company beat estimates on both the top and bottom line, including revenue growth of 15% and an EPS of $0.04 -- $0.02 better than expectations. In addition, the company raised guidance, estimating that revenue will grow 5% from quarter to quarter; the consensus was for growth of just 3.4%.
So, why in the world did its stock fall by so much? Top-line and bottom-line estimates and guidance are usually the key areas that investors look at when a company reports. Instead, the market reportedly focused on two areas of weakness.
For one, the company expects margins to decline another 100 basis points . Advanced Micro has faced margin problems for the better part of two years. Back in 2010, operating margins were 12.6%, but during the last 12 months, margins have slipped to just 7.8%. Further margin declines are not something investors will welcome.
The second problem is that Advanced Micro is losing market share to its largest competitor, Intel , in the PC space. It's no secret that PC sales have been weak over the last couple years, but market share is very important for chipmakers and other component manufacturers such as hard-disk-drive makers.
Goldman notes that Intel saw just a 3% year-over-year decline in PC division sales during its last quarter. Comparably, Goldman believes that Advanced Micro lost 15% in the same division, thus suggesting a loss in market share. Moreover, Goldman thinks Intel's new Bay Trail Atom CPU could put additional pressure on Advanced Micro.
Clearly, Advanced Micro shares are lower on this combination of news.
While lost market share to Intel is no doubt bad news, investors must also consider the company's valuation and how it applies to expectations.
In case you need a fundamental reminder, a stock is nothing more than a reflection of current earnings and future expectations. As a company grows and ups its guidance, a stock will trade higher, and a higher multiple -- P/E or price/sales ratio -- will be awarded.
With this in mind, Advanced Micro is not profitable on a net-income basis, but nonetheless is still valued as a company with very low expectations. It trades at just 0.63 times sales. In comparison, the S&P 500 trades at 1.55 times sales and the technology sector trades close to 3.0 times sales. Also, Advanced Micro's closest competitor, Intel, trades at 2.3 times sales, which is also a discount to the overall market; most likely due to the overall decline in the PC market.
However, given Advanced Micro's discount to just about every major benchmark, doesn't it seem fair or reasonable that it would be losing market share? To me, Intel's ratio of 2.3 times sales is reflective of a struggling company in a weak industry. Advanced Micro's multiple reflects that of a company with rock-bottom expectations. Hence, why was Goldman's note a shock to the market?
With that question in mind, Advanced Micro may have traded lower illogically after clearly beating estimates on all fronts, and when such an event takes place, it usually creates a value opportunity.
Finding new growth drivers
I like to invest in growth. Therefore, Advanced Micro is not really my cup of tea. However, value investors might notice that Advanced fell without valid reason, and that there are a lot of positives for the company.
Most notably, in a PC market that's declining 10% annually, Advanced Micro has found sanctuary in the game-console market. In previous years, console-related revenue accounted for a small percentage of total sales, but Wedbush Securities believes that consoles might now account for up to 28% of total sales , surging to $401 million in this last quarter.
Advanced Micro's silent shift to consoles reminds me of another company that has flourished despite a weak PC market, and that is Western Digital . This is a company that makes hard disk drives, which are storage devices found in PCs and laptops.
Western Digital faced the same industry-related problems as Advanced Micro, but has made investments in solid-state drives -- storage used mostly in smartphones and tablets -- and in the cloud. As a result, Western Digital has become a well-diversified storage company across all fronts and has seen its valuation increase 105% in the last year.
Moreover, in the last five years, Western Digital has soared 400%, which is a result of countless acquisitions and total assets that have increased from $7 billion in 2010 to $14 billion today; these assets have aided in making the company more diversified.
I'm not suggesting that Advanced Micro is the next Western Digital, but I think both companies' decisions to lessen their reliance on PCs and tablets to focus on emerging segments is wise for long-term value. With that said, let's not forget that Advanced Micro did beat estimates and did raise guidance, and that a weak margin outlook is likely temporary.
In many ways, the fact that it lost share in the PC space yet beat revenue estimates should be viewed as a positive, a sign that the company is producing growth elsewhere. At $3.50 and with expectations very low, Advanced Micro might be worth a long hard look.
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The article Were These Earnings as Bad as Advertised? originally appeared on Fool.com.
Brian Nichols has no position in any stocks mentioned. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel and Western Digital.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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