Advanced Micro Devices, Inc. Stock (NASDAQ:AMD) could be 35% higher than its intrinsic value estimate

Key insights

• The estimated fair value of Advanced Micro Devices is $115 based on a two-step free cash flow to equity

• The current share price of $155 suggests that Advanced Micro Devices is potentially 35% overvalued

• Our fair value estimate is 39% below Advanced Micro Devices’ analyst price target of $188

How far is Advanced Micro Devices, Inc. (NASDAQ:AMD) from its intrinsic value? Using the latest financial data, we’ll check whether the stock is fairly valued by taking the company’s projected future cash flows and discounting them back to today’s value. On this occasion, we will use the discounted cash flow (DCF) model. Before you think you won’t be able to understand it, just keep reading! It’s actually much less complicated than you might think.

Remember, however, that there are many ways to estimate the value of a company, and DCF is just one of them. Anyone interested in learning more about intrinsic value should check out the Simply Wall St analytical model.

Check out our latest analysis for Advanced Micro Devices

What is the estimated valuation?

We use what’s called a two-stage model, which simply means we have two different periods of growth rates for the company’s cash flow. Generally speaking, the first stage is the higher growth stage and the second stage is the lower growth stage. First, we need to estimate cash flows over the next ten years. Where possible we use analyst estimates, but when these aren’t available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume that companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect the fact that economic growth tends to slow more in the early years than in later years.

We generally assume that a dollar today is more valuable than a dollar in the future, so the sum of these future cash flows is then discounted to today’s value:

Free cash flow (FCF) forecast for 10 years

(“Est” = FCF growth rate estimated by Simply Wall St)
10-year Present Value of Cash Flows (PVCF) = $72 billion

The story continues

After calculating the present value of the future cash flows over the initial 10-year period, you need to calculate the Final Value, which takes into account all future cash flows after the first stage. The Gordon Growth formula is used to calculate terminal value with a future annual growth rate equal to the five-year average 10-year government bond yield of 2.4%. We discount the final cash flows to today’s value at a cost of equity of 8.5%.

Final value (TV)=FCF₂₀₃₃ × (1 + g) ÷ (r – g) = USD 15 billion × (1 + 2.4%) ÷ (8.5% – 2.4%) = USD 255 billion

Present Value Final Value (PVTV)= television / (1 + r)¹⁰= $255 billion ÷ ( 1 + 8.5%)¹⁰= $113 billion

The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is $185 billion. In the last step, we divide the value of equity by the number of shares outstanding. Compared to the current share price of $155, the company’s valuation appears potentially overvalued at the time of writing. However, valuations are imprecise instruments, a bit like a telescope – you just need to move a few degrees and find yourself in another galaxy. Remember that.

Important assumptions

The most important inputs to discounted cash flows are the discount rate and, of course, actual cash flows. Part of investing is making your own assessment of a company’s future performance, so try doing the math yourself and check your own assumptions. DCF also does not take into account the possible cyclicality of the industry or the company’s future capital requirements, so it does not provide a complete picture of the company’s potential performance. Given that we view Advanced Micro Devices as a potential shareholder, the discount rate is the cost of equity capital rather than the cost of capital (or weighted average cost of capital, WACC), which takes into account debt. We used 8.5% in these calculations based on a leveraged beta of 1.327. Beta is a measure of a stock’s volatility compared to the market as a whole. We obtain our beta from the industry average beta of comparable companies around the world, with an imposed limit of 0.8 to 2.0, which is a reasonable range for a stable business.

SWOT analysis for advanced micro devices

Resilience

Weakness

Possibility

Danger

Looking to the future:

Valuation is only one side of the coin when it comes to building an investment thesis, and it shouldn’t be the only metric you look at when searching for a company. The DCF model is not an ideal tool for stock valuation. It’s best to use different cases and assumptions and see how they affect the company’s valuation. If a company is growing at a different pace, or if its cost of equity capital or risk-free rate changes dramatically, the results may look very different. Why is intrinsic value lower than the current share price? For advanced microdevices, there are three important factors that need to be further explored:

1. Financial condition: Does AMD have a healthy balance sheet? Check out our free balance sheet analysis with six simple checks on key factors like leverage and risk.

2. Future earnings: How does AMD’s growth rate compare to competitors and the broader market? Take a closer look at analyst consensus for the coming years with our free analyst growth expectations chart.

3. Other high quality alternatives: Do you like a good all-round player? Check out our interactive list of high-quality stocks to find out what else you might be missing!

PS. Simply Wall St performs daily discounted cash flow valuations for every stock listed on the NASDAQGS exchange. If you want to find calculations for other stocks, just search here.

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This article by Simply Wall St is of a general nature. We comment based on historical data and analyst forecasts, using only an unbiased methodology, and our articles are not intended to provide financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide long-term, focused analysis based on fundamental data. Please note that our analysis may not reflect the latest price-sensitive company announcements or qualitative content. Simply Wall St has no position in any of the stocks mentioned.

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