This Is AMD's Biggest Hurdle in an AI Sell-Off (and No, It's Not Nvidia)

Advanced Micro Devices (NASDAQ: AMD) has sold off in recent trading sessions. Amid an artificial intelligence (AI) chip shortage, it has thrived, as the leading AI chip company, Nvidia (NASDAQ: NVDA), is unable to meet all of the demand.

Admittedly, if the AI industry slowed and Nvidia could serve all interested customers, investors might have less reason to buy from AMD. But in that case, one overlooked factor could have the most effect on investors.

Image source: The Motley Fool.

The supreme threat to AMD stock

Right now, the most pressing risk to AMD shareholders is the stock's valuation.

Currently, its price-to-earnings (P/E) ratio stands at 139. That is several times higher than the earnings multiples of Nvidia, Broadcom, and Taiwan Semiconductor. Additionally, AMD's forward P/E ratio of 72 appears to confirm the overvaluation.

Data source: YCharts.

Worse, that valuation is probably based on its future as an AI chip producer. Indeed, if more customers turn back to Nvidia, investor interest in AMD stock could plummet. Moreover, if AMD's P/E ratio falls to Nvidia's current level, the stock could lose close to 80% of its value, a factor that may cause some investors to rethink their positions.

AMD the stock vs. AMD the company

The silver lining here is that the valuation is more of a threat to the stock than to the company.

For one thing, AMD's data center business, which designs AI chips, accounted for 58% of the company's revenue in the latest quarter. While that is a lot, investors should remember that the company also operates gaming, client, and embedded segments, providing some diversification. In comparison, the data center segment made up almost 93% of Nvidia's revenue, making it close to an all-in play on AI chips.

Secondly, even in a downturn, it would likely be a mistake to write off AMD's AI chips. For one, many customers have built systems around them, which will likely make them reluctant to switch away from AMD. Also, agentic AI, a technology that can operate with minimal supervision, could propel the chipmaker to new heights under the right circumstances.

Additionally, AMD's AI accelerators have typically sold at lower prices than Nvidia's. This probably means that even in a plausible worst-case scenario, it will likely maintain a following among more budget-conscious customers.

Moving forward with AMD stock

In the end, AMD investors should worry more about the chip stock's valuation than about the future of its AI chip business.

The stock's high valuation and a desire for diversification motivated me to reduce my AMD holdings. However, I am also a long-term investor and chose to maintain a substantial position in AMD stock. Despite my concerns about valuation and the possibility of an AI bust, I believe the need for chips will likely increase in the long term.

The company has established itself as a major player in the industries in which it operates. Over time, I expect its growth to catch up to its valuation.

Will Healy has positions in Advanced Micro Devices. The Motley Fool has positions in and recommends Advanced Micro Devices, Broadcom, Nvidia, and Taiwan Semiconductor Manufacturing. The Motley Fool has a disclosure policy.