AMD Reports Tuesday. One Number Decides Whether 54 Times Forward Earnings Was Ever Defensible.

Advanced Micro Devices (NASDAQ: AMD) reports its second-quarter results on Tuesday, Aug. 4, after the market closes, with an earnings call to follow at 5 p.m. ET. The chipmaker confirmed the date in a press release on its investor relations site in early July.

The stock heads into the report at about $476, where it closed Friday, roughly 19% below its 52-week high of $584.73. At that price, the company carries a market capitalization of about $776 billion, and shares trade at about 162 times earnings and about 54 times forward earnings estimates.

A valuation like that isn't a bet on the company as it exists today. It's a bet on how fast one segment's revenue keeps growing: data center. I'll say up front that I like the business here more than I like the price.

Image source: Getty Images.

What data center did last quarter

AMD's first quarter, reported in early May, showed why investors have been willing to pay up. Total revenue rose 38% year over year to $10.3 billion. Data center segment revenue grew 57% to $5.8 billion, driven by demand for the company's EPYC server processors and its Instinct line of artificial intelligence (AI) accelerators. For the second consecutive quarter, the segment delivered more than half of the company's total revenue.

"We delivered an outstanding first quarter, driven by accelerating demand for AI infrastructure, with Data Center now the primary driver of our revenue and earnings growth," CEO Lisa Su said in the company's first-quarter earnings release.

The rest of the business helped, too. Client and gaming segment revenue rose 23% year over year to $3.6 billion, with the client business (chips for laptops and desktops) up 26% to $2.9 billion on demand for Ryzen processors. Even the gaming business, long the sleepy corner of the company, grew 11% to $720 million.

And the growth reached the bottom line. Non-GAAP (adjusted) earnings per share rose 43% year over year to $1.37, compounding faster than revenue itself. Adjusted gross margin came in at 55%.

The bar Tuesday has to clear

Management's own guidance frames what Tuesday needs to deliver. AMD guided for second-quarter revenue of about $11.2 billion, plus or minus $300 million, implying roughly 46% year-over-year growth -- an acceleration from the first quarter's 38%. It also guided for adjusted gross margin of about 56%, a point above the first quarter's level.

Put another way, the company itself set the bar at faster growth, again. And since data center is now more than half of revenue and growing far faster than the rest, the segment's number on Tuesday is effectively the whole test. So, can the 57% data center growth rate hold, or even climb, as the year goes on?

To justify a price near 54 times forward earnings estimates, AMD's profits would need to keep compounding at a rapid pace for years, not quarters. That is possible. And AMD's own guidance suggests its momentum carried through the second quarter.

But the bar is high, I think, in a way the price-to-earnings ratio makes obvious. At 162 times the earnings the chipmaker has already produced, years of that improvement are effectively priced in.

But if data center growth merely decelerates (not declines, just slows), a stock at this multiple can fall hard. The price leaves little room for an ordinary quarter.

The third-quarter guide may matter just as much as the quarter itself. A company that told investors to expect 46% growth needs its next forecast to hold the pace, and any step-down in the implied growth rate could weigh on the stock more than the reported numbers do.

To be fair, AMD has cleared every bar set for it lately. Revenue growth has stepped up from 38% toward a guided 46%, margins are widening, and earnings are compounding faster than sales.

Ultimately, though, I'm not buying the stock ahead of the report. The business is performing wonderfully, but at 54 times forward estimates, that performance is the starting assumption rather than the upside. If Tuesday's report shows data center accelerating again and the third-quarter guide holds the pace, I'd revisit my thinking, even at a higher price. I'll wait for the numbers first.

Daniel Sparks and his clients do not have positions in any of the stocks mentioned. The Motley Fool has positions in and recommends Advanced Micro Devices. The Motley Fool has a disclosure policy.