AMD Underreacts (To Guidance)
- In response to a clearly negative Q4 earnings announcement, AMD shares have surged more than 27% from the ER date.
- The counter-intuitive price moves may be a mixture of investors’ response to a simultaneous mix of downside Q1 and Q2 2019 revenue forecasts and upside Q3 and Q4 2019 revenue estimates.
- I developed a forward-looking AMD model which prices the stock based on management’s guidance on revenue, EPS, and gross margin of the next 4 quarters.
- Based on the historical way how AMD shares used to respond to guidance changes, the 27% gain is deemed excessive.
- AMD’s shareholders have "underreacted" to the negative information conveyed by the downside revenue guidance. Just based on guidance alone, AMD shares have been traded at a $4 premium or overvalued by 20%.
After Nvidia’s (NASDAQ: NVDA) surprise pre-warning of a lower Q4 revenue guidance, AMD (NASDAQ: NASDAQ:AMD) was expected to deliver a similar disappointing Q4 earnings release (ER) for the crypto-related excess inventory. Just a few days later, AMD announced that it missed Q4 revenue, met EPS, and lowered Q1 revenue guidance, yet AMD's shares surged close to 30% in response.
Of course, this is a particularly volatile time for the stock market. With ongoing trade war negotiation, Fed’s changing stance of interest rate policy, and a looming global economic slowdown, investors are hungry for any clues to indicate the future outlook. Given most bellwether stocks like Facebook (NASDAQ: FB), Apple (NASDAQ: AAPL), Taiwan Semiconductor Manufacturing Company (NYSE: TSM), and AMD and Nvidia Q3’s ERs have been already punished by the market for their downside revenue guidance, it is not surprising that AMD shareholders have initially reacted to the Nvidia’s warning of the downside guidance. However, it's surprising how AMD can respond so positively to its own obviously negative ER. Many have offered justifications to the counter-intuitive share price reactions as "not as bad as Nvidia's pre-warning has suggested," "the market has priced in the worst," and "AMD's downside guidance is not as bad as the pack." Some argued that just like briefly hitting $34 after Q3 ER, AMD shares have been in a bubble. Incidentally, around the same time, one of AMD’s largest shareholders Mubadala Investment disclosed selling 34.9M shares and plans to convert 75M warrants. In this post, I like to offer my take that AMD has underreacted to its downside revenue guidance and the 27% gain was excessive.
Stock Price and Revenue Guidance
Generally, Wall Street takes management guidance very seriously. As guidance is often the only source of company’s new information, analysts use it to formulate their estimates and recommendations. Accordingly, in Figure 2A, there is a clear correlation between AMD share price rise and fall with management revenue guidance around the same time. As guidance has been priced some time ago, AMD shareholders are more sensitive to guidance revisions (Figure 2B). The intense sensitivity can be demonstrated by the stock price movement in response to the revenue guidance revisions.
AMD 2019 Revenue Guidance
Whenever AMD lowered their Q4 2018 revenue guidance, the Street adjusted their forward estimates almost instantly (Circle A in Figure 1A). This is why street estimates are closely tracking guidance and stock prices react both to changes in guidance and estimates. Furthermore, stock prices (in black) are generally responding negatively to the same direction of the lower guidance changes as identified by circle A in Figure 1A. This is why it came as a surprise that the most recent downside Q1 and Q2 revenue guidance was accompanied by a surge in AMD stock prices (Circle B in Figure 1A). One way to explain the inconsistency is that the market may have reacted to a better forecast of 2H 2019 (Q3 and Q4 2019) as indicated by the upward revision of Q3 and Q4 2019 revenue estimates (Circled B in Figure 1B).
Given that the near-term guidance has been lowered but the longer-term guidance has been raised, it is plausible that AMD prices may have reacted positively as a result. Intuitively, the 27% increase for a 3-day post-ER move seems excessive by any reasonable standard for a generally negative guidance. This is why, in the following section, I will try to estimate the fair price reaction considering both the short-term and long-term guidance changes.
Guidance Compliance Target Price
At this juncture of significant economic uncertainty, it appears that AMD stock price has reacted to the future revenue guidance more than anything else. Using the relationship between AMD’s stock price and management’s guidance, I was able to estimate a “guidance-compliance target price” which is determined by the guidance metrics, including management guidance on future revenue, EPS, or gross margin, if provided. The way I came up with this implicit guidance price is as follows: I first collect all management guidance, stock price, and consensus estimate data on revenue, EPS, and gross margin for the last 40 quarters. Then, I correlated AMD stock prices with the management guidance or street estimates of revenue, EPS, and gross margin for the current and next 4 quarters, if available. The relationship I identified would suggest how today’s stock price moves in response to the management guidance for the next 4 quarters. Furthermore, in light of the tariffs-related, China slowdown impact on the broader market, I also include the NASDAQ index in the estimation to control for the macro impact on AMD stock prices.
In Figure 3, I showed how this stock price guidance should have looked like, compared with the actual AMD stock prices. For the better part of 2018, AMD actual stock price (black line) has moved closely with what guidance has suggested (the red line). This would give me comfort about the validity of the assumption that investors did look at management guidance in pricing AMD shares.
In the meantime, the same estimates also showed the drastic difference emerging right after AMD’s Q4 ER downside guidance, actual stock prices have jumped over the guidance-suggested prices frequently. As a result, AMD is currently trading around $23, 20% higher than the fair value $19.3 according to the Q4 guidance. In other words, if just using guidance changes as the base to explain the post-ER price changes, (which is the only new information released since Q4 ER), AMD shares appear overvalued in the short run.
Starting early 2018, AMD’s stock has entered a new phase. Most likely, the historically beat down AMD has become a turnaround success story and the best recommended 2019 stock picks in most tech portfolios. However, just like a year ago, the extreme optimism may easily open the possibility of a speculative bubble forming. Investors need to come to the ground that stock prices, even for the most beloved stocks, should be valued at the forward-looking financials in the long run, albeit negatively in the short run. Accordingly, in this post, I used management’s perspective to estimate the proper AMD share price reaction to their revenue estimate changes for the next four quarters. The evidence suggests that AMD’s shareholders have underreacted to the negative information conveyed by the downside revenue guidance. Just based on guidance alone, AMD shares have been traded at a $4 premium, which translates to being overvalued by 20%.
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