NVDA Vs. AMD: Which Is The Better Buy?

Sep. 28, 2022 5:26 PM ETAdvanced Micro Devices, Inc. (AMD), NVDA49 Comments
Allen Greathouse profile picture
Allen Greathouse
751 Followers

Summary

  • Can Nvidia and AMD sustain their impressive growth, especially in light of the new US ban on AI-Enabled Chip Sales to China on national security concerns?
  • Just 5 years ago, Nvidia’s stock traded at around $40 a share, AMD, around $10 a share. Flash forward to today and Nvidia’s shares 5X’d and AMD’s 10x’d.
  • M&A should become increasingly more challenging for AMD and Nvidia, so I would expect their returns on invested capital to moderate/diminish over the long term.
  • The Chinese lockdown and pandemic-related supply chain problems have slowed chip fabrication. But on the other hand, the conflict in Ukraine threatens the global energy market and could spill into a global recession.

Global car chip shortage

golibtolibov

Introduction

For growth investors, 2022 has been a rocky year... to say the least.

Entering the new year, I wondered if the tech stock crash of 2021 was behind us, or if we were at the start of something greater, something far more severe. It's probably a bit too early to tell whether we are through the worst of it but now seems like a prudent time to pause and think about valuation. Especially, the valuation of some of the most important chip stocks on the planet, Nvidia (NASDAQ:NVDA) and AMD (NASDAQ:AMD).

Chart
NVDA data by YCharts

Just 5 years ago, Nvidia's stock traded at around $40 a share, AMD, around $10 a share. Flash forward to today, Nvidia's shares 5X'd and AMD's 10x'd.

Not a bad return. And that's after having crashed almost 50% off of their highs set in late 2021.

But can this trend continue? Do shares still represent a good value at today's prices? And furthermore, how might a potential recession, and/or Chinese chip ban affect these stocks?

Within this Article, I'll:

  • Provide a business update for AMD and NVIDIA

  • Perform a financial analysis between AMD and NVIDIA

  • Provide my valuation based on two different frameworks for both stocks

Business Update and Macro Discussion

Recessionary Fears

For the entirety of 2022, it's felt like the entire financial community has been laser-focused on the odds of a recession. And it's easy to understand why. Inflation is rampant, supply chain issues remain, and Russia has closed the tap on Europe for energy… And that's all while we try to reopen the economy we artificially closed due to the COVID-19 pandemic.

Odds of Recession

Odds of Recession (Statista: Bloomberg)

We're genuinely in unchartered waters and the jury is very much still out on where we will go from here.

But unfortunately for chip makers AMD and Nvidia, regardless of the outcome, uncertainty can be harmful. As uncertainty increases, corporate investments slow. Semis are just not as sticky as SaaS usually is. For example, a $10 monthly fee is a lot easier to swallow than a $1000 investment into the latest chipset.

If hard times are coming, it's easier to just put off that chip investment.

Want vs Need

Or to put it another way, paying for SaaS is like paying your water bill, and Chips are like paying for a kitchen remodel. I love having a nice kitchen, but I need water. If I might lose my job in the coming months, I'm not going to remodel my kitchen.

A chip investment can be delayed, but if you don't pay Microsoft, you lose Outlook and Excel, what happens then? It all comes back to want vs. need, just like in personal finance 101.

(Granted, these companies do have growing SaaS businesses, but it's dwarfed by their traditional chip business. Given its small size, I don't find it particularly relevant for this analysis.)

So when companies chose to delay "remodeling their kitchen" based on increased uncertainty, we can expect it to harm chip companies like NVIDIA and AMD.

End Markets

Traditionally, the names Nvidia and AMD were known for their gaming chips, but they're increasingly moving beyond gaming. Nvidia has a strong and growing presence in data centers, and AMD moved into a variety of verticals when it acquired Xilinx.

Gaming Market Growth

Gaming Revenue Growth by Segment

Gaming Revenue Growth by Segment (Statista)

Despite the strength, the gaming market has had historically, and its strong growth forecasts, from a tactical perspective, it makes sense to not keep all your eggs in the same basket, AMD and Nvidia seem to share that perspective given their push into other verticals.

I'm particularly optimistic about Nvidia's progress in the data center where they continue to take share from legacy players leveraging their AI-enabled chips. As more data moves to the cloud companies, like Amazon (AMZN) and Microsoft (MSFT), they are likely to buy even more Nvidia chips.

AMD and Nvidia Earnings

Over last month, we got updates from both companies on their financial performance and commentary as to where they see things going from here.

I won't rehash what has already been said elsewhere on Seeking Alpha, but both companies released what I think was a mixed bag. The problem is that growth appears to be slowing drastically, and their forecasts reflect that.

The China Debacle

Speaking of slowing growth, have you heard the news? The US is banning the sale of advanced AI enable chips to China, one of the largest chip markets in the world.

China now consumes more than 60% of world's semi-conductor output; U.S. portion of sales is shrinking

Global Chip Consumption (Handel Jones, IBM)

This has many implications for Nvidia and AMD. For one, Nvidia is known to be the leader in AI-enabled chips, which can supercharge processing speeds far beyond what they would be otherwise, it especially will be hurt as they lose one of their largest growth markets.

AMD appears to be less affected as the company put out a statement this morning stating:

We do not currently believe [the ban] is a material impact on our business.

This ban reflects the rising tensions off the Chinese coast between Beijing and Washington as China weighs plans to incorporate Taiwan back into the mainland and the US looks to maintain the status quo.

A weaker Chinese military, vis-a-vis less advanced chips, in the eyes of the US, likely reduces the risk of a military escalation or full-on attack across the Taiwan Strait.

Taiwan, China - Wikipedia

Map of PRC vs ROC (Wikipedia)

This will likely cause short/medium-term pain for Nvidia, and potentially AMD too, but in my view, this ban is a long-term positive for their business. Both businesses benefit by having a secure Taiwan, unaffected by war, continuing to fabricate their chip designs. If China were to attack, the global chip market would be paralyzed, and substantially, all of their revenue would be at risk.

CKGSB

CKGSB

Looking at the data above, we can see that China's demand for chips has grown to a massive size. In 2016, China consumed over half of the overall demand for chips, so investors are right to be worried.

But just how worried should investors be?

Well, consider the fact that decades ago, many millions of Chinese citizens were impoverished and are just now getting access to luxuries like microwaves and cellphones. It's probable, in my view, that the demand in China for chips is geared much more heavily toward the type of less advanced chips that AMD and Nvidia do not produce.

So you're looking at the loss of a substantial gaming market, that's a real loss, but it's not a game changer, nor does it upend any long-term growth trajectories, at least in this author's view.

Product Pipeline

To stay on top of the competition, Nvidia and AMD continue to invest billions of dollars into innovation and R&D. While both companies continue to shift their focus away from gaming and towards other verticals like AR and AI, I believe that gaming will remain a lucrative source of both companies' earnings for years to come.

To show the power of what these chips can do, I recommend you read Nvidia's blog post detailing some of the advanced capabilities of their new 40 series chips.

Nvidia

Nvidia

Through what Nvidia calls its "ADA LOVELACE" architecture, they claim gamers will enjoy computing performance that is leaps above prior iterations: turing and ampere.

Another area of innovation comes from AMD with its Ryzen line of chips. To further boost the power of their chips, AMD and Nvidia both employ software that allows the computing power of these chips to exceed what would otherwise be possible. You can read more about these chips here.

Financial Analysis

Revenue Growth

It should come as no surprise that these companies massively grew their revenues through the pandemic era. Revenues are up 2-3x for both companies as gamers invested in their computers and cloud providers continued to invest in their data centers.

Source: Yahoo Finance, Author's Calculations & Estimates

Source: Yahoo Finance, Author's Calculations & Estimates

Ignoring share count fluctuations, revenue growth has been pretty much neck and neck. Both companies have had slower growth comparing TTM to last year's numbers, but since 2020, they've generally grown at an outsized rate compared to many other companies on the market.

Gross Margins

Source: Yahoo Finance, Author's Calculations & Estimates

Source: Yahoo Finance, Author's Calculations & Estimates

Both Nvidia and AMD have excellent margin profiles. Even AMD's lower gross profit margin of 49% is exceptional and speaks to the earnings power of these businesses. These margins aren't just good for a chip company, they're great compared to almost any company.

Source: Yahoo Finance, Author's Calculations & Estimates

Source: Yahoo Finance, Author's Calculations & Estimates

On a per share basis, both companies have grown gross profit by a similar (and impressive) amount over the last 4 years, although Nvidia is showing some signs of slowing.

Dilution

Source: Yahoo Finance, Authors Calculations & Estimates

Source: Yahoo Finance, Authors Calculations & Estimates

Source: Yahoo Finance, Authors Calculations & Estimates

Source: Yahoo Finance, Authors Calculations & Estimates

Another factor working in these companies' favor has been dilution, or rather, the lack thereof. Sure, AMD has issued around 150k shares over the last 4 years, but that's nothing compared to some SaaS players (looking at you Palantir…). Nvidia has been especially prudent in maintaining its share count. The share count has only increased by 35k over the past 4 years, not bad.

Dilution is not always a bad thing, but all things considered, I'd rather own more of the company than less of the company. That is why I often look at revenue and gross profit on a per-share basis.

Valuation

Forward PE Comparison

Company Stock Price Next Year Earnings Est Next Year P/E
NVDA 124 4.6 27.0
TXN 161 8.9 18.1
AMD 67 4.9 13.7
AVGO 465 40.0 11.6
QCOM 120 12.7 9.4
Average PE 16.0

Source: Yahoo Finance, Authors Calculations & Estimates

When I value companies, I like to employ a handful of methods. My two favorites are the discounted cash flow analysis and comparing the forward price to earnings ratios among peers.

Source: Yahoo Finance, Author's Calculations & Estimates

Source: Yahoo Finance, Author's Calculations & Estimates

As you can see in the charts above, Nvidia has the highest forward PE ratio, while older peers like Broadcom and Qualcomm are farther behind, much closer to 10x than 30x. AMD sits relatively in the middle of the pack, along with Texas Instruments.

Based on their forward PEs alone, AMD looks like a much better value than Nvidia, but both may still be overvalued compared to some of their slower-growing peers.

Discounted Cash Flow Analysis

For both AMD and Nvidia, I'm using the same assumptions in my base case, given their similar historical growth rates for both revenue and gross profits.

Metrics

Assumptions

Discount Rate

11.00%

Revenue CAGR

20%

Terminal Growth

2%

Nvidia Base Case:

Year

Year 1

Year 2

Year 3

Year 4

Year 5

Revenue

$26,914.0

$33,340.0

$38,400.0

$46,080.0

$55,296.0

Net Income

$9,625.0

$13,350.0

$15,650.0

$18,451.3

$22,141.6

Cash Flow

$7,700.0

$10,680.0

$12,520.0

$14,761.1

$17,713.3

NVDA Current Stock Price

$97

DCF Implied Share Price:

$103.90

In my base case scenario, I'm forecasting Nvidia to reach an astounding $55B in revenue within 5 years and over $20B in earnings, which would mean more than doubling in size in just 5 years. Even in that optimistic scenario, shares appear to be trading at just fair value. They do not scream "buy" to me at these prices.

Nvidia Sensitivity Analysis:

9% Discount Rate

11% Discount Rate

13% Discount Rate

Bull Case: 30% Revenue Growth

$201.0

$146.1

$112.3

Base Case: 20% Revenue Growth

$141.0

$103.9

$80.9

Bear Case 10% Revenue Growth

$97.4

$73.0

$57.9

For those who may dispute either my growth rate or discount rate, I've included a sensitivity analysis for both Nvidia and AMD. As you can see in the chart above, for Nvidia to be a money maker, one would need to forecast an exceptionally high growth rate and accept a significantly lower discount rate.

AMD Base Case:

Year

Year 1

Year 2

Year 3

Year 4

Year 5

Revenue

$16,434.0

$26,180.0

$29,440.0

$35,328.0

$42,393.6

Net Income

$3,162.0

$7,097.8

$7,924.3

$9,578.0

$11,493.6

Cash Flow

$3,220.0

$5,678.3

$6,339.4

$7,662.4

$9,194.9

AMD Current Stock Price

$67.20

DCF Implied Share Price:

$83.20

In the case of AMD, I have revenue growing to $42B and earnings growing to $11B, again, more than double where they are now. Can this be achieved? Perhaps, but it is by no means certain. Luckily for AMD, according to this DCF, its shares are not nearly as overpriced as Nvidia's are.

AMD Sensitivity Analysis:

9% Discount Rate

11% Discount Rate

13% Discount Rate

Bull Case: 30% Revenue Growth

$161.0

$117.0

$90.0

Base Case: 20% Revenue Growth

$112.9

$83.2

$64.8

Bear Case 10% Revenue Growth

$78.0

$58.5

$46.4

AMD fairs a bit better than Nvidia due to its lower valuation, but it's my view that the prospects are still not especially appetizing as an investor. At least with AMD, its lower valuation gives you a bit more wiggle room than Nvidia, so I'll give them that.

Risks

As I mentioned at the top of this article, a recession, or fear of one, could damage their business. Given all the uncertainty out there, combined with the fed raising rates, I think that this is a significant downside risk for either company.

Another challenge these companies face is their scale. Both companies are >$100B in market cap, which may pose some unique challenges as they continue to grow. Companies have 4 main ways of using capital, dividends, buybacks, M&A, and internal projects.

After all the internal projects are funded, in many cases, the next best use is M&A. But as we saw with Nvidia's failed attempt to takeover ARM, scale can impede growth by M&A. Because M&A will become increasingly more challenging for them, I would expect their returns on invested capital to moderate/diminish over the long term.

Conclusion

Nvidia and AMD are both great companies. They've created some of the most advanced computing chips on the market and rewarded their shareholders handsomely. As they grew, they both diversified into verticals beyond gaming and personal computing, thus, further strengthening the long-term viability of their businesses.

But not all remarkable things can go on forever. The gaming end market in particular has seen an especially strong slowdown as consumers have begun to spend more on real-world experiences instead of in-game purchases. Because of their diversified revenue bases, AMD and Nvidia can offset some of the effects from data center and auto.

For Nvidia and AMD, my view is that this is going to come down to supply and demand. The Chinese lockdown and pandemic-related supply chain problems have slowed chip fabrication. But on the other hand, the conflict in Ukraine threatens the global energy market and could spill into a global recession. So supply is constrained but improving, and demand is strong but may be waning. I don't particularly like that setup as an investor.

And with valuations among the highest of the peer group, that doesn't leave much of a cushion for error. Add in the US ban on AI-enabled chips being sold to China, and I'm now even less confident.

I rate Nvidia "Underperform" with a 1-year price target of $88.

I rate AMD "Neutral" with a 1-year price target of $65.

Thank You For Reading

Thank you to everyone who made it to this point. I hope you all enjoyed the article. I try to get back to all commenters with a response, so if you have a question or comment, please feel free to share it below.

This article was written by

Allen Greathouse profile picture
751 Followers
MBA Grad, Financial Analyst Current portfolio strategy consists of a variety of growth stocks, and dividend growth stocks with an emphasis on high quality, and scalability. Primarily a buy and hold investor with >30 year time horizon.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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