Before selecting a stock, there are a number of things that you need to consider in order to ensure that you are buying the stock of a high-quality company whose shares are poised to grow in value over time. Some of these concerns include what the company does, its competitive advantages, valuation, dividend payouts and sustainability, and earnings consistency.
Another important thing that you need to consider is the financial condition of the company in question. You want to know if the company is able to continue paying its bills, and how much debt it carries. The balance sheet is one of the most effective tools that you can use to evaluate a company's financial condition. In this article, I will discuss the balance sheet of Advanced Micro Devices (AMD) in order to get some clues as to how well this company is doing.
I will go through the balance sheet, reviewing the most important items, in order to assess AMD's financial condition. The information that I am using for this article comes from the company's website here.
Note that this article is not a comprehensive review as to whether AMD should be bought or sold, but rather, just an important piece of the puzzle when doing the proper due diligence.
Many of you who are well-versed in AMD may find this article as simply stating the obvious. However, someone who doesn't know much about AMD, and is just starting to research it, may derive some benefit from it.
AMD is a global semiconductor company, with operations worldwide. The company's business is divided into two segments. They are Computing Solutions and Graphics and Visual Solutions. The Computing Solutions segment offers x86 microprocessors as standalone devices, or as incorporated as accelerated processing units (APU), for commercial and consumer markets. This segment also offers embedded microprocessors for commercial and consumer markets, and chipsets for desktop and mobile devices, like PCs, laptops, and tablets. The Computing Solutions segment of AMD contributed 74% of the company's revenue in 2012.
The Graphics and Visual Solutions segment offers graphics processing units (GPUs), including professional graphics and semi-custom system-on-chip products. Operations in this segment also include revenue received in connection with development services and game console royalties. This segment was responsible for 26% of AMD's revenue in 2012.
Cash and Cash Equivalents
The first line in the Assets column of the balance sheet is for the amount of cash and cash equivalents that the company has in its possession. Generally speaking, the more cash the better, as a company with a lot of cash can invest more in acquisitions, repurchase stock, pay down debt, and pay out dividends. Some people also value stocks according to their cash positions. Some of the larger and more mature companies tend not to carry a lot of cash on their balance sheets, as they might be more inclined to buy back stock with it, or pay out dividends.
As of Sept. 28, 2013, AMD had $1.06B in cash and short-term investments, which can be easily converted into cash. This is a lot of cash for a company with a $2.53B market capitalization. This means that the company is trading at less than 3 times its cash position, which may make the stock very attractive to value-oriented investors.
However, there are reasons why the company is trading so cheaply. One of these reasons might be the fact that the company produced a negative free cash flow of $818M over the last 12 months. The company also had negative free cash flows during fiscal years 2012 and 2010, while just barely coming out positive in 2011. The company has not paid out any dividends, and was a net issuer of company stock over the last three fiscal years.
Receivables constitute money that is owed to a company for products or services that have already been provided. Of course, the risk with having a lot of receivables is that some of your customers might end up not paying. For this reason, you usually like to see net receivables making up a relatively small percentage of the company's sales.
AMD had a total of $873M in net receivables on its balance sheet, which represents 18.7% of its trailing 12-month sales of $4.68B. For fiscal 2012, 11.6% of its sales were booked as receivables, while that percentage was at 14.0% for fiscal 2011.
This percentage has jumped quite a bit over the last nine months. This may be due to either changing product mix or the company being more lenient on its payment policies.
Another factor that I like to look at is the current ratio. This helps to provide an idea as to whether or not the company can meet its short-term financial obligations in the event of a disruption of its operations. To calculate this ratio, you need the amount of current assets and the amount of current liabilities. Current assets are the assets of a company that are either cash or assets that can be converted into cash within the fiscal year. In addition to cash and short-term investments, some of these assets include inventory, accounts receivable, and prepaid expenses. Current liabilities are expenses that the company will have to pay within the fiscal year. These might include short-term debt and long-term debt that is maturing within the year, as well as accounts payable (money owed to suppliers and others in the normal course of business). Once you have these two figures, simply divide the amount of current assets by the amount of current liabilities to get your current ratio.
If a company's operations are disrupted due to a labor strike or a natural disaster, then the current assets will need to be used to pay for the current liabilities until the company's operations can get going again. For this reason, you generally like to see a current ratio of at least 1.0, although some like to see it as high as 1.5.
The current ratio of AMD is 1.67, which is very good.
Property, Plant and Equipment
Every company, regardless of the industry in which it operates, requires a certain amount of capital expenditures. Land has to be bought, factories have to be built, machinery has to be purchased, and so on. However, less may be more when it comes to outlays for property, plant and equipment, as companies that constantly have to upgrade and change their facilities to keep up with competition may be at a bit of a disadvantage.
However, another way of looking at it is that large amounts of money invested in this area may present a large barrier-to-entry for competitors. Right now, AMD has $358M worth of property, plant and equipment on its balance sheet. This figure is well below the $658M that the company reported at the end of fiscal 2012, as well as the $726M that it reported at the end of fiscal 2011. This big change over the last nine months can be attributed to the sale of several office and industrial buildings. Of their remaining PP&E assets, 85% are in equipment, while 13% are in buildings.
Goodwill is the price paid for an acquisition that's in excess of the acquired company's book value. The problem with a lot of goodwill on the balance sheet is that if the acquisition doesn't produce the value that was originally expected, then some of that goodwill might come off of the balance sheet, which could in turn lead to the stock going downhill. Then again, acquisitions have to be judged on a case-by-case basis, as good companies are rarely purchased at or below book value.
AMD has $553M worth of goodwill on its most recent balance sheet, which is the same as it reported 9 months prior, but higher than the $323M that they reported at the end of fiscal 2011. This increase is due to the company's March 2012 acquisition of Sea Micro, a provider of energy-efficient, high-bandwidth microservers.
Overall, goodwill accounts for about 12.8% of AMD's total assets. Usually, I don't like to see goodwill account for more than 20% of a company's total assets for the reason that I discussed at the beginning of this section. Since AMD is well below this threshold, I don't see much to be concerned about here.
Return on Assets
The return on assets is simply a measure of the efficiency in which management is using the company's assets. It tells you how much earnings management is generating for every dollar of assets at its disposal. For the most part, the higher, the better, although lower returns due to large asset totals can serve as effective barriers to entry for would-be competitors. The formula for calculating return on assets looks like this:
Return on Assets = (Net Income) / (Total Assets).
Unfortunately, a meaningful return on assets for AMD cannot be calculated for the trailing 12-month period or for fiscal 2012, due to the company producing losses for those time periods. Over the last 12 months, the company produced a non-GAAP loss of $230M, while during fiscal 2012, they produced a non-GAAP loss of $114M. I did calculate AMD's returns on assets over fiscal years 2011 and 2010, when they did make money, for comparative purposes. This can be seen in the table below.
Table 1: Returns On Assets At AMD
Their returns on assets were looking pretty good until 2012, when they started losing money, due to falling sales, which management attributes to subpar macroeconomic conditions and reduced demand of PCs, in favor of tablets. Over the last 9 months, things seem to have deteriorated further.
Short-Term Debt Versus Long-Term Debt
In general, you don't want to invest in a company that has a large amount of short-term debt when compared to the company's long-term debt. If the company in question has an exorbitant amount of debt due in the coming year, then there may be questions as to whether the company is prepared to handle it.
AMD currently has just $5M in short-term debt, which is not a problem when considering its cash position, which is north of $1B.
Long-term debt is debt that is due more than a year from now. An excessive amount of it can be crippling in some cases. For this reason, the less of it, the better. Companies that have sustainable competitive advantages in their fields usually don't need much debt in order to finance their operations. Their earnings are usually enough to take care of that. A company should generally be able to pay off its long-term debt with 3-4 years' worth of earnings.
Right now, AMD carries $2.04B of long-term debt, which matches what the company reported at the end of fiscal 2012. This figure is higher than the $1.53B that was reported at the end of fiscal 2011. Of this debt, 50% is due within the next five years, starting in 2015. The rest is due in 2020 and 2022. Most of this debt is in the form of senior notes that carry interest rates of anywhere between 6.0% to 8.1%.
In determining how many years' worth of earnings it will take to pay off the long-term debt, I use the average of the company's core earnings over the last 3 fiscal years. The average core earnings of AMD over this period is just $207M. When you divide the long-term debt by the average earnings of the company, here is what we find.
Years of Earnings to Pay off LT Debt = LT Debt / Average Earnings
For AMD, here is how it looks: $2.04B / $0.207B = 9.86 years
This shows that it would take an amount that is almost equal to 10 years worth of past earnings to pay off AMD's long-term debt. And, of course, given that AMD has been losing money over the last 21 months with no end in sight, I probably shouldn't put much emphasis on that calculation. With about $1B worth of debt coming due, starting in just two years, it will be interesting to see how AMD deals with this.
The debt-to-equity ratio, as normally calculated, is simply the total liabilities divided by the amount of shareholder equity. The lower this number, the better. Companies with sustainable competitive advantages can finance most of their operations with their earnings power rather than by debt, giving many of them a lower debt-to-equity ratio. I usually like to see companies with this ratio below 1.0, although some raise the bar (or lower the bar if you're playing limbo) with a maximum of 0.8. Let's see how AMD stacks up here.
Debt-To-Equity Ratio = Total Liabilities / Shareholder Equity
For AMD, the debt-to-equity ratio is calculated by dividing its total liabilities of $3.89B by its shareholder equity of $0.434B. This yields a debt-to-equity ratio of 8.96.
From this, AMD appears to be severely distressed.
The table below shows how the debt-to-equity ratio has changed over the last few years.
Table 2: Debt-To-Equity Ratios Of AMD
Table 2 shows that AMD is not in good shape at all with regard to its debt and equity positions, and the situation is getting worse instead of better.
Return On Equity
Like the return on assets, the return on equity helps to give you an idea as to how efficient management is with the assets that it has at its disposal. It is calculated by using this formula.
Return On Equity = Net Income / Shareholder Equity
Generally speaking, the higher this figure, the better. However, it can be misleading, as management can juice this figure by taking on lots of debt, reducing the equity. This is why the return on equity should be used in conjunction with other metrics when determining whether a stock makes a good investment. Also, it should be mentioned that some companies are so profitable that they don't need to retain their earnings, so they buy back stock, reducing the equity, making the return on equity higher than it really should be. Some of these companies even have negative equity on account of buybacks. However, AMD is not one of these companies.
As was the case with return on assets, meaningful return on equity calculations for AMD over the last 12 months and fiscal 2012 can't be made due to losses. However, figures are given in the table below for 2010 and 2011.
Table 3: Returns On Equity At AMD
Table 3 shows that returns on equity have only gotten worse, at least for the last three years.
Retained earnings are earnings that management chooses to reinvest into the company as opposed to paying it out to shareholders through dividends or buybacks. It is simply calculated as:
Retained Earnings = Net Income - Dividend Payments - Stock Buybacks
On the balance sheet, retained earnings is an accumulated number, as it adds up the retained earnings from every year. Growth in this area means that the net worth of the company is growing. You generally want to see a strong growth rate in this area, especially if you're dealing with a growth stock that doesn't pay much in dividends or buybacks. More mature companies, however, tend to have lower growth rates in this area, as they are more likely to pay out higher dividends.
Below, you can see how the retained earnings have fared at AMD at the end of each of the last four fiscal years.
Table 4: Retained Earnings At AMD
From the above table, we can see that AMD has an accumulated deficit, which means that this company has been losing money for some time. Note that these figures contain the GAAP earnings, and not the non-GAAP earnings that I have been referencing up to this point.
After reviewing the most recent balance sheet of AMD, there's not much good to say about it. While the company's stock trades at less than 3 times its cash position, and carries a pretty decent current ratio, everything else pretty much stinks. Right now, the company sports negative returns on both assets and equity due to losses. AMD carries a relatively high amount of debt that makes me wonder how they are going to pay it off with a steadily shrinking cash position, and negative earnings. And, of course, with no earnings, there is no money for AMD to reinvest into the company to try to get back on track, as can be seen in the retained earnings.
More information on how I analyze financial statements can be found at my website here. It's a website that I created in order to help people make more intelligent financial decisions.
Thanks for reading, and I look forward to your comments.