AMD's Data Center Business Doubled to $6.7 Billion. The Stock Fell 9% Because of What That Growth Costs.

Shares of Advanced Micro Devices (NASDAQ: AMD) fell about 9% in Tuesday's after-hours session after the chipmaker reported its second-quarter results. That was just hours after the stock closed the regular session up 7%.

The odd part is that the quarter itself was excellent. Revenue rose 50% year over year to a record $11.5 billion, and data center revenue more than doubled.

Why did a report that strong knock shares back to about $473, as of this writing?

The likeliest reason, I think, is in the outlook: Management guided for another quarter of rapid revenue growth, but for a gross margin that stays flat while capital spending climbs.

In other words, investors got fresh confirmation of AMD's growth on Tuesday -- along with a clearer picture of what that growth costs to produce.

Image source: AMD.

A record quarter, led by data center

AMD's data center segment generated $6.7 billion of revenue in the second quarter, up 107% from $3.2 billion a year earlier, driven by its EPYC server processors and Instinct line of artificial intelligence (AI) accelerators. The segment now accounts for 58% of the company's total revenue, and it earned $2.1 billion in operating income. That marked a swing from a small loss a year earlier, when $800 million of charges tied to U.S. export restrictions on AMD's China-bound MI308 chips weighed on results.

Profits grew faster than revenue, too. Non-GAAP (adjusted) earnings per share came in at $1.66, up 82% year over year once last year's export-related charges are excluded. And adjusted gross margin reached 56%, up about two percentage points from the year-ago quarter on that same comparable basis.

Demand could keep building from here. AMD recently launched Helios, its first rack-scale system (a full data center rack combining the company's processors, accelerators, and networking chips).

And in July, it announced an agreement with AI company Anthropic to deploy up to 2 gigawatts of its Instinct MI450 chips in Helios racks.

"We expect Data Center sales to accelerate in the second half of 2026, driving stronger overall revenue growth and continued earnings expansion," chief financial officer Jean Hu said in the company's second-quarter earnings release.

Clearly, AMD's growth isn't the problem.

What the growth costs

The concern shows up in the third-quarter outlook. Management guided for third-quarter revenue of about $13 billion, plus or minus $300 million (about 41% year-over-year growth), while adjusted gross margin holds at about 56%, flat with the second quarter.

When revenue jumps 13% from one quarter to the next and gross margin doesn't budge, the new revenue is arriving at margins no better than the company's existing average.

After a year in which AMD's comparable gross margin expanded about two points, management expects no improvement. The pause comes right as Helios racks begin shipping to customers including Meta Platforms, OpenAI, and Oracle, with volumes expected to ramp in the fourth quarter. A full rack carries far more hardware than a chip does, and those early systems don't appear to be lifting margins yet.

Capital spending is climbing even faster. AMD spent $808 million on capital expenditures during the quarter, nearly triple the $282 million it spent a year earlier and about double its first-quarter spending. Free cash flow of $1.6 billion equaled about 14% of revenue, well below the company's 24% adjusted net income margin. That spending alone accounts for about two-thirds of the gap.

The pressure isn't limited to the data center, either. Client and gaming revenue rose 6% year over year, but the segment's operating margin slipped to 15% from 21% a year earlier as operating expenses climbed.

Even after the after-hours decline, the stock isn't cheap. At about $473, shares cost around 43 times forward earnings estimates -- roughly double the 21 times that AI chip rival Nvidia trades for on the same basis.

Paying that kind of premium arguably only makes sense if AMD's profits eventually compound as fast as its revenue does. Of course, one flat quarter of margin guidance isn't proof that they won't, and margins may well resume climbing as Helios production matures.

So, does Tuesday's sell-off make the stock a buy? Not for me. I like this business a lot, and the quarter cleared a high bar.

Ultimately, though, at this price I'd want to see the margins moving up before paying the premium. If gross margin starts climbing as Helios scales, I could get interested. For now, however, I'm staying on the sidelines.

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, Meta Platforms, Nvidia, and Oracle. The Motley Fool has a disclosure policy.