Is Advanced Micro Devices a Buy?

Though the last few months have been rough going, Advanced Micro Devices (NASDAQ: AMD) stock ended 2018 sporting a nearly 80% gain. Share prices are off their highs reached during the fall, though, as the company's sales momentum has slowed and a broader stock market sell-off has taken its toll. Though the chipmaker is still forecasting growth ahead, investors should use caution here.

2018 momentum is fading... for now

AMD's big gains last year are easy to explain: New demand for the company's products for video gaming, personal computers, laptops, and data centers led to much higher sales compared to a year ago.

Sales and profit increases led to the stock's meteoric rise, but third-quarter results indicated a slowdown for AMD. Sales were up only 4% year over year, and adjusted EBITDA was up 23%. That's nothing to balk at, but nevertheless was much slower than the previous few quarters' results. Management sees sales increasing 8% year over year in the fourth quarter, and gross margins rising to 41%.

The cooldown is in keeping with an overall slowdown in momentum for semiconductor companies that occurred in 2018. It all started with memory chips, an especially up-and-down concern, but other chipmakers got hit, too. AMD was no exception, as was the case for its peer NVIDIA (NASDAQ: NVDA), which took an especially hard tumble as demand for graphics chips related to the cryptocurrency boom last year wore off. That's a headwind that AMD has acknowledged is weighing on results right now, too, and could persist for a couple more quarters.

A big pullback, but still not cheap

Despite a steep drop the last few months from its high point, AMD still isn't a cheap stock. Trailing price to earnings is at 56.9, and one-year forward price to earnings is 30.5 -- supporting Wall Street's expectations that bottom-line profits will continue to improve in the immediate future. Even with the more modest sales growth outlook from management, AMD could certainly pull off another big year of bottom-line increases if its profit margins keep rising as anticipated.

Nevertheless, headwinds are mounting for the chip sector, and AMD is priced at a premium to its immediate competition. After getting beat up after its last quarterly report, NVIDIA is trading at only 17.1 and 17.8 times one-year trailing and one-year forward price to earnings, respectively, versus AMD trading at 55.2 and 27.5 trailing and forward earnings, respectively. If AMD experiences a similar slowdown -- or even a slight contraction -- in chip sales, shares could shed even more value.

However, it's hard not to be enamored with the semiconductor industry in general. The digital revolution is lifting demand for chips across many industries, providing a secular tailwind for the entire sector. However, with near-term weakness in graphics cards and AMD priced at a premium, the stock isn't a slam-dunk buy. Shares could fall further before a rebound gets underway, so investors should use caution at this point.

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Nicholas Rossolillo and his clients own shares of Nvidia. The Motley Fool owns shares of and recommends Nvidia. The Motley Fool has a disclosure policy.