Better Buy: Advanced Micro Devices, Inc. vs. Intel

By Markets Fool.com

With the PC market in decline, both Advanced Micro Devices and Intel are feeling the pain. Global PC shipments dropped 9.8% in 2013, 2.1% in 2014, and 10.4% in 2015, driven by a combination of factors including the rise of mobile devices and the failure of Windows 10 to trigger an upgrade cycle. 2016 isn't off to a better start, with global PC shipments slumping 11.5% year over year during the first quarter.

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Both AMD and Intel are still heavily dependent on the PC market, although both companies are working to change that. AMD has built up its semi-custom chip business, with its SoCs powering the major game consoles, and the company plans to make a run at the server chip market next year with its upcoming Zen CPUs. Intel dominates that market, with the company's server chip business acting as a source of both growth and outsize profits, partially offsetting PC-related weakness.

With both AMD and Intel facing considerable challenges, which is the better buy?

The case for AMD

Image source: AMD.

A quick look at AMD's financial statements reveals that the company is in serious trouble. Revenue dropped 28% in 2015 driven by a weak PC market, share losses to Intel, and share losses to NVIDIA in the graphics card market. The company posted a $660 million net loss on $3.99 billion of revenue, the fourth annual loss in a row. AMD's book value, or assets minus liabilities, turned negative.

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The company expects this year to mark the turning point of its efforts to turn the business around. AMD's guidance calls for a return to revenue growth, driven by new semi-custom design wins and the upcoming launch of its Polaris graphics cards. Non-GAAP operating profitability is expected to return during the second half of the year, a massive improvement over 2015.

AMD provided similarly optimistic guidance last year, but the company came up far short and was forced to abandon those targets just a few months later. I don't fully trust AMD's guidance for that reason. But if Polaris is a success, and if Zen, which launches for PCs toward the end of this year and for servers next year, follows suit, AMD stock could be worth far more than it trades for today. The company sports a market capitalization of just $2.8 billion, down more than 80% over the past decade. A return to profitability in 2017 or 2018 would likely send the stock soaring.

What makes AMD stock risky is the chance that something goes wrong. NVIDIA currently dominates the graphics card market, shipping around 80% of cards during the fourth quarter last year, and its upcoming Pascal graphics cards are set to launch in the same timeframe as Polaris. If Polaris fails to win back meaningful market share from NVIDIA, AMD's guidance could again prove to be overly optimistic. AMD stock has plenty of upside potential, but it comes with plenty of risk as well.

The case for Intel

Image source: Intel.

Intel investors have been subject to a parade of bad news in recent weeks. First, the company announced plans to lay off up to 12,000 employees, or roughly 11% of its global workforce, by the middle of next year in an effort to adjust to lower demand for PCs. Second, Intel announced it is essentially giving up on the mobile market, at least for the time being, by axing its SoFIA and Broxton chips.

With the PC market showing no signs of turning around, Intel expects its data center and Internet of Things businesses to be the key growth drivers for the company going forward. During 2015, the data center segment generated $7.85 billion of operating profit, nearly as much as the client computing segment, while growing revenue by 11%. The rapid rise of cloud computing has been a boon for the company, with Intel enjoying a near-monopoly in the server chip market.

The bad news is that competition is coming. AMD will launch new server chips in 2017, potentially winning back some market share, and initiatives from International Business Machines and ARM Holdings to create viable alternatives in the data center are slowly gaining momentum. Earlier this month, Alphabet's Google announced that it was working to develop a server architecture based on IBM's POWER chips, a move that could mark the beginning of the end of Intel's uncontested data center dominance.

There are a lot of headwinds working against Intel at the moment, but the company is still very profitable. During 2015, Intel generated net income of $11.4 billion, putting the P/E ratio of the stock at about 12.8. With that valuation, investors aren't betting on much growth for Intel going forward.

Still, if the PC market eventually stabilizes and Intel manages to fight off encroaching competition in the data center segment, Intel would likely be able to maintain its profitability. And potential growth areas like the Internet of Things and 3D XPoint memory could drive earnings higher in the long run. Intel's growth story isn't dead, but earnings growth is no longer a foregone conclusion, and a substantial earnings decline is possible if things don't go Intel's way.

Which is the better buy?
Neither AMD nor Intel look like particularly attractive investments at this point. AMD has more upside potential, but the company needs to deliver with its upcoming product launches, something it's had problems with in the past. Intel has an attractive valuation assuming earnings don't decline, but the company is facing major headwinds as PC sales slump and its efforts in mobile fizzle.

Intel is the safer bet, simply because the company is wildly profitable and enjoys some significant competitive advantages. AMD has the potential to soar, but it also has the potential to crash and burn if Polaris and Zen come up short. For most investors, Intel looks like the better buy, despite the myriad problems facing the company.

The article Better Buy: Advanced Micro Devices, Inc. vs. Intel originally appeared on Fool.com.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Timothy Green owns shares of International Business Machines. The Motley Fool owns shares of and recommends Alphabet (A and C shares) and NVIDIA. The Motley Fool recommends Intel. 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.