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Why AMD Stock Could Rise as PS5 and Xbox Supply Stabilizes

Motley Fool - Tue Jun 7, 6:32AM CDT

AMD(NASDAQ: AMD) is one of the world's leading semiconductor companies, providing computing hardware such as processors, motherboards, graphics cards, and more for some of today's most sought-after technology. The company's stock is down more than 20% in the last six months but that could all change thanks to AMD's key position in the production of Sony's (NYSE: SONY) PlayStation 5 and Microsoft's (NASDAQ: MSFT) Xbox Series X/S.

Surging sales despite chip shortage

AMD supplies processors and graphics cards for both of those current leading video game consoles. Sony reported selling 10 million PS5s in July 2021, making it the fastest-selling console in the company's history. Microsoft similarly revealed in the same month that its Xbox Series X/S consoles were its "fastest-selling consoles ever, with more consoles sold life-to-date than any previous generation." Both gaming machines were first launched in November 2020 as the next generation of consoles, replacing the PlayStation 4 (2013) and Xbox One (2013).

An adult man and woman sit with a young girl between them. All three are holding PlayStation controllers and looking forward, smiling.

Image source: Getty Images.

Sony and Microsoft announced soaring console sales amid the COVID-19 pandemic, which put severe supply strains on the tech world. Advances in technology increased semiconductor demand by 17% from 2019 to 2021, and when lockdowns shut down factories, higher demand and lower supply led to an ongoing chip shortage . Nearly every tech industry has been hit by the shortage, from car manufacturers to smartphone retailers. Yet Sony and Microsoft were still able to pull off impressive sales despite their inability to fully meet consumer demand.

As the pandemic eases and the semi-conductors become more readily available, AMD will be able to supply more of its products, thus putting more game consoles on the shelves and into people's homes. Sony Senior Vice President Veronic Rogers said on June 3, 2022, that the company has plans to significantly "ramp up" PS5 production this year. Microsoft, on the other hand, has paid a variety of factories for chip priority in an effort to increase Xbox Series X/S production.

A win for Sony and Microsoft is a win for AMD

AMD splits its revenue into two segments: "computing and graphics" and "enterprise, embedded, and semi-custom." The former encompasses the company's PC processors, chipsets, and graphics hardware, while the latter is its enterprise processors and custom architectures, such as those found in the PlayStation and Xbox consoles. Of AMD's $5.9 billion in Q1 2022 revenue, $2.8 billion came from computing and graphics, while $2.5 billion came from enterprise, embedded, and semi-custom.

Interestingly, whereas computing and graphics made $723 million in operating income for AMD, enterprise, embedded, and semi-custom brought in a larger $881 million. The company essentially keeps $0.26 for every dollar of revenue made in the former segment, while the latter -- containing gaming consoles -- brings in $0.34.

AMD does not report individual sales figures for each company it supplies its products to, nor does it break out how much of its enterprise, embedded, and semi-custom sales come from console chips. But the higher margins in the enterprise, embedded, and semi-custom category suggest that any significant sales growth there will provide a boost to profits. AMD's most recent quarterly report also attributed its recent sales growth in that segment to PS5 and Xbox Series X/S sales.

Additionally, Sony and Microsoft will almost certainly release higher-powered "Pro" versions of their consoles as the generation continues. Both companies did so with their previous generation of consoles, launching the initial consoles in 2013 and then a pro version three to four years later. The pro consoles would similarly gain their power from AMD's top-of-the-line processors and graphics card technology, adding to the company's growth.

If supply chain constraints continue in the tech industry, there is a chance that Microsoft and Sony will be unable to meet consumer demand for their consoles, hurting AMD. However, with COVID-19 easing and countries opening up again, inventory should continue to improve. By supplying hardware in both Sony and Microsoft consoles, AMD benefits no matter which console comes out on top -- and that's before you even consider that the company supplied similar components for Valve's increasingly popular Steam Deck, a handheld gaming console.

A good long-term buy

AMD's stock price looks unusually low compared to its stellar recent earnings. The company's revenue totaled $16.4 billion in 2021, up 68% from the previous year. Similarly, its gross profit came to $7.9 billion in 2021, up 82% from 2020.

AMD PE Ratio Chart

AMD PE Ratio data by YCharts

The semiconductor company's price-to-earnings ratio is currently far below its long-term average, suggesting its recent stock price does not reflect AMD's true value. Perhaps chipmaker stock investors are nervous about the recent chip shortage or simply uncomfortable investing in tech, but whatever the reason, the price seems likely to rebound over the long term.

As stock for both consoles has been exceedingly low since their launch, it would be helpful to check on local store supply. If stores such as GameStop, Target, Walmart, and others can keep PS5s and Xbox Series X/Ss on the shelves, it will mean that inventory has finally leveled and AMD is profiting.

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Fool contributor Dani Cook holds no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Advanced Micro Devices, Microsoft, and Target. The Motley Fool has a disclosure policy.

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