• AMD will release its quarterly earnings on Tuesday, October 31

• Earnings growth expected to turn positive, after sharp declines

• Valuation is slightly stretched, but shares seem attractive overall

AMD enters the AI wars

The artificial intelligence (AI) revolution has taken the semiconductor industry by storm, generating an enormous amount of demand for advanced chips that can be used to train these complex models. Nvidia is currently the undisputed leader in this rapidly growing market, with an estimated market share of around 80% for AI chips.

It took some time for AMD to join this race, but it entered with a bang. Chief executive Lisa Su announced that the flagship MI300 artificial-intelligence chip will be released later this year, allowing the company to finally compete with Nvidia in the field of accelerator chips.

In other words, while Nvidia is the dominant player, AMD might be able to steal some market share away and establish itself as the number-two player, as it did with gaming graphics cards and data center chips after that.

Reflecting this optimism, AMD shares have risen by 48% this year, even as earnings growth declined.

Earnings set to recover

It’s been a tough year for earnings. In the first and second quarters of the year, AMD saw earnings decline by around 45% from the same periods last year. Most of this weakness reflected a post-pandemic hangover, as many clients over-ordered last year during the chip shortages, essentially pulling demand forward.

Hence, AMD’s gloomy results this year can be considered a ‘normalization’, with clients ordering less because they are already sitting on huge inventories. But earnings growth might be stabilizing at last. For the third quarter, earnings are expected to have increased 1% from the same quarter last year, while revenue is projected to have risen by 2.3%.

Not very impressive earnings growth, but at least the company’s financials seem to be improving after a painful loss streak. In terms of market impact, the subsequent earnings call with AMD executives could be even more important than the numbers themselves. Specifically, investors will be looking for fresh clues on the company’s strategy in the AI market.

Looking at the charts, AMD shares have been in a steady decline over the last four months, recording a series of lower highs and lower lows. The price also closed below its 200-day moving average this week, which is an ominous sign.

In case of surprisingly strong earnings or cheerful guidance by management, the stock could rise to challenge the 99.50 region, where a successful break could see scope for extensions towards the congested 105.00 zone. On the other hand, a disappointment could send the market below the September low of 94.50 and perhaps all the way down to the 91.00 region.

Valuation is stretched, but not crazy

Turning to valuation metrics, AMD shares are trading at 24 times forward earnings, which is a relatively attractive valuation for a company with such tremendous growth prospects ahead. However, this valuation assumes that earnings will grow 51% next year, according to analysts covering the stock.

That number seems overly optimistic. The AI boom might still be in its early stages, but the global economy is slowing down at an alarming pace, which could dampen demand for chips next year. Therefore, the valuation is probably less attractive than it appears at first glance, as there’s a clear risk of earnings falling short of these rosy projections.

However, from a longer term perspective, the valuation is not excessive for a company that could be the second-most dominant player in the AI wars. In other words, the near-term prospects for AMD shares remain clouded, but the longer term outlook seems bright.