Across the United States, there are over 600,000 individuals who receive live updates for business developments regarding the stock of Advanced Micro Devices (AMD). This tech company manufactures chipsets, microprocessors, and embedded systems applications. In some niches, it is the second largest competitor to Intel. And well, there are a lot of people out there who think that AMD will create the kind of 21st century wealth that Intel created for shareholders during the second half of the 20th century (and as you know from our past discussions, that means mind-boggling money as the $18 billion opportunity cost to the Grinnell endowment indicates).
One of the things that you need to study carefully while waiting for a business model to mature is the cost of your patience. When you own shares of a business that is unprofitable, you need to undergo an honest analysis of the expected time horizon before profits arrive and the funding sources that will keep the business operationally solvent while you wait. You then must compare this projected cost to the likelihood of a future payoff, and your conclusion will reveal whether the stock is worth holding or not.
Since the days of the dotcom era, investors have been convinced that profitability was just around the corner for shareholders of Advanced Micro. There was a rational basis for thinking that AMD would start raking in the big bucks, as it offered a glimmer in 2001 when it earned $36 million in profit even though management correctly warned that it wouldn’t last (by 2002, the tech firm was reporting losses of over $600 million).
Much like the Sears stock that has always come with an analyst assurance of a turnaround, shareholders of Advanced Micro have spent almost the first two decades of the 21st century listening to stories about how meaningful profitability would soon be in the offing.
Meanwhile, the corporation has lost $5 billion in the past seventeen years.
Where does a corporation come up with $5 billion? You have two options—debt and equity issuance. AMD did some of the former, and whole lot of the latter. It borrowed $1 billion, and it raised $4 billion issuing hundreds of millions of shares of stock.
Back in 2000, AMD had 314 million shares outstanding. Now, it has 925 million shares. That is share count expansion of 194%. That is obscene. That is wealth destructive. The implication is that AMD would have needed to grow earnings by 7% annually during this sixteen-year time frame just to break even with the rate of dilution.
Recently, people have gotten excited about the fact that AMD reported three cent profits in the third quarter of 2016 and the price of the stock rose from $1.8 to $10 in the past year.
I understand the perpetual excitement for stocks in the microchip industry. The wealth is largely the result of intellectual property innovation with low raw material costs, and a successful product launch can be incredibly scalable in a short amount of time.
But enthusiasm must be tempered by a recognition that the consistent issuance of new shares will perpetually dilute your ownership claim on those future profits. AMD issued 115 million shares of stock in the past eighteen months, and will issue another 100 million shares or so within the next two years.
That matters. It suggests an additional 10-15% dilution is in the short-term offing. Right now, AMD is a $10 billion company with $4.5 billion in revenues and $150 in annual operating losses.
As a short term trade, Advanced Micro could be a fine stock. I offer you no opinion on the short-term merits of the stock. But on a five to ten year basis, the terms are much less favorable. There is a reason why the investors of 2000 are down 80% on their investment in the first quarter of 2017. It is because of ridiculously high share count dilution. That factor is still at work dragging down the payoff for future earnings growth.
Perhaps AMD will eventually launch that billion-dollar profitable product. But the cost of waiting has been immense. Every year that goes by, each share has a 7% smaller claim on whatever that eventual payoff may be. In light of these historic conditions, which persist through the present day, I would remove this stock from consideration as an investment as a threshold matter. When your claim on future profits ticks smaller and smaller with each passing year, the likelihood of losses mounts while the value of the potential payoff diminishes.