Portfolio holding Advanced Micro Devices (AMD) is among the best-performing S&P 500 stocks on Tuesday. Its gains are part of a broad rally on Wall Street, especially in hard-hit pockets like semiconductors, as some investors look for bargains following weeks of carnage. The stock managed to finish at the highs of yesterday's trading range even after another hawkish commentary from Federal Reserve Chairman Jerome Powell (here).

Piper Sandler upgrades AMD

AMD shares are up more than 8% Tuesday, and a big reason why appears to be Piper Sandler’s upgrade of the stock. Harsh Kumar, a chip analyst at the firm, now has an overweight rating on AMD and a price target of $140, up nearly 50% from where it closed Monday. Kumar previously had a neutral rating and $98 price target.

To provide some context to this call, back in January, the analyst downgraded AMD to neutral. Now, after the stock has fallen more than 34% this year, "it’s time to get constructive on the name again,” Kumar wrote in his note. “There are two old sayings in the investment world: 1) You cannot time the market, so do not try and 2) Buy good companies when they are down.” 

In an interview Tuesday on CNBC (which we listened to and reporting here for you), Kumar explained that his upgrade is not strictly due to the price action in the stock, but also from strong fundamental. Kumar had previously expected AMD to be hurt by a slowdown in PC sales in 2022 and that AMD’s acquisition of Xilinx wouldn’t be materially impactful right away. “As it turns out, AMD is navigating those headwinds extremely well,” Kumar said yesterday, noting that AMD’s focus on high-end PCs has protected it from a sales slowdown in lower-end PC market. 

AMD closed on its all-stock Xilinx acquisition in February, as part of its data-center push, and it “has turned out to be a good one for these guys.” In the first quarter, Xilinx’s revenue grew 22% on a year-over-year basis. “So with the stock having come in dramatically lower ... and trading at just a 20 multiple on a forward basis, we thought it would be a good time for our investors to, perhaps, take a look at AMD,” the analyst noted.

Big picture

The broader semiconductor sector has been clobbered so far this year. The VanEck Semiconductor ETF (SMH) entered Tuesday’s session down more than 26% year to date. Semiconductors are traditionally considered cyclical, as they go into manufacturing equipments, machineries, cars, and consumer discretionary devices such as gaming consoles, all of which can be materially affected when the economy is running out of steam. 

Kumar told CNBC he upgraded the entire sector Tuesday — not just AMD — as valuations have retreated to be more in line with their averages in recent history. “We went negative on the sector at the beginning of the year, on Jan. 3, and we just basically said stocks have come in enough,” Kumar said. 

He believes the possibility of a recession is priced into the share prices of many semiconductor firms. “You look at semiconductor companies. They all have free cash flow. They have very strong earnings power. We’re still in short supply of that raw material, and with this 15% calculus that I’m applying to haircutting the earnings, I think we’re pretty much there,” Kumar said.

Kumar’s pivot on AMD is welcome news to the Club as shareholders because we’ve believed the selling had become overdone.

Portfolio's AMD position

We were disciplined enough to have sold shares in the $160s late last year, when valuations were getting stretched. Despite shares being down ~35% YTD, we're only down ~8% for our AMD position because our portfolio-construction mechanism has allowed us to generate a relatively attractive cost basis of ~$110. Our most recent purchase was in April, in the low $80/share. 

Since we made the ~80$/share purchase with a relatively large size, our discipline does not allow us to buy more at this price. However, we strongly recommend subscribers with little or no AMD position to buy at this price, even after Tuesday's analyst-driven price appreciation. On a next twelve-month P/E multiple basis, shares of AMD are trading at historically low levels not seen since 2018, in the low twenties. However, the company is growing at an incredibly fast pace, with revenue growth ~60% yoy. This makes the Price-to-Earnings-to-Growth ratio* of this stock to be about 0.4, indicating the stock is significantly undervalued compared to its growth performance and potentials. For perspective, Apple (AAPL) has a PEG ratio of 2.45 yet it is only growing revenues at 18% yoy. To put it another way, Apple is only growing at 18% yoy and investors are willing to pay 2.45 times that on the P/E basis. On the other hand, AMD is growing at 60% yoy, yet investors are paying about one-third less on a P/E basis. Bottom line, we believe this is ridiculously cheap, arguing for a significant price appreciation to come in the next few months.