Forget Texas Instruments, AMD Is a Better Semiconductor Stock

Texas Instruments (NASDAQ: TXN) disappointed investors last quarter as its revenue and earnings dropped 11% and 9% year-over-year, respectively. Those declines -- which TI attributed to macro headwinds throttling its sales to all "major customers, regions, and technologies" -- slammed semiconductor stocks across the board.

TI's dim outlook for the fourth quarter, which anticipates a 10%-17% annual drop in revenue and a 14%-28% decline in earnings, exacerbated its sell-off. TI's problems are mainly cyclical, but investors looking for a stronger semiconductor play should consider AMD (NASDAQ: AMD) instead.

Image source: Getty Images.

A more focused business

Unlike AMD, which produces powerful CPUs and GPUs, TI sells a wide range of lower-cost analog, embedded, and other chips to multiple industries. TI's broad portfolio of lower-power chips is often cited as a major strength, since it isn't heavily exposed to a single customer or industry.

However, TI's diversification becomes a weakness during economic downturns, which simultaneously reduce demand across multiple sectors. During cyclical downturns, chipmakers with a narrower focus and customer base -- like AMD -- can fare better.

AMD generated 71% of its revenue from its computing and graphics segment last quarter. This division sells its Ryzen CPUs and Radeon GPUs, which compete against comparable chips from Intel (NASDAQ: INTC) and NVIDIA (NASDAQ: NVDA), respectively. AMD controls 30% of the CPU market, according to PassMark Software, as well as 27% of the discrete GPU market, according to Jon Peddie Research.

The remaining 29% of its revenue came from its enterprise, embedded, and semi-custom (EESC) business, which sells custom chips for gaming consoles (including the PS4 and Xbox One) and Epyc CPUs for servers.

In short, AMD relies on just three main catalysts to drive its growth:

1. Gaining market share in CPUs against Intel in the PC and server markets
2. Holding NVIDIA at bay in the GPU market
3. Remaining the main chip supplier for Sony and Microsoft's next-gen consoles.

Its growth over the past year indicates that it's accomplishing most of those goals.

Better revenue growth

AMD's revenue growth decelerated in the first half of the year due to lower sales of GPUs and system on chips (SoCs) for consoles, but those declines weren't surprising. Many gamers postponed their GPU upgrades ahead of new GPU launches in the second half, and sales of the PS4 and Xbox One were both expected to decline ahead of the new console launches next year.

Image source: Getty Images.

However, AMD's revenue rose 9% annually in the third quarter, as its 36% annual growth in computing and graphics revenue offset a 27% drop in EESC revenues. AMD attributed that big jump to higher sales and average selling prices (ASP) for its new CPUs and GPUs, which indicates that it's holding Intel and NVIDIA at bay. AMD's recovery looks encouraging, especially when compared to Texas Instruments' streak of revenue declines over the past year:

YOY = Year-over-year. Source: Quarterly reports.

AMD expects that momentum to continue with a whopping 48% annual jump in revenue in the fourth quarter, fueled by robust sales of its Ryzen, Eypc, and Radeon chips. Analysts expect AMD's revenue to rise 4% this year and 27% next year. TI's revenue is expected to dip 10% this year and another 1% next year.

Lower margins but better earnings growth

Texas Instruments' gross margin is in the mid-60s, and AMD's gross margin is in the low 40s. TI's higher margins aren't surprising, since producing analog and embedded chips is a less capital-intensive process than developing x86 CPUs and discrete GPUs.

However, AMD's stronger revenue growth and steady margins enable it to generate much stronger earnings growth than TI. Wall Street expects AMD's earnings to grow 35% this year and 76% next year -- stellar growth rates for a stock that trades at 36 times forward earnings.

TI's earnings are expected to fall 8% this year and dip another 2% next year. That's not a good path forward for a stock that trades at 24 times forward earnings. TI's forward dividend yield of 3% and its tradition of spending "all" its free cash flow on dividends and buybacks should set a floor under the stock -- but it's tough to spot any near-term catalysts.

The bottom line

AMD still faces some tough battles against Intel and NVIDIA, but the recent demand for Ryzen, Epyc, and Radeon chips strongly indicates that brighter days are ahead. TI won't fade away anytime soon, but it's clearly a weaker semiconductor play for growth-oriented investors.

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Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Leo Sun has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Microsoft and NVIDIA. The Motley Fool owns shares of Texas Instruments. The Motley Fool recommends Intel and recommends the following options: long January 2021 $85 calls on Microsoft and short January 2020 $50 calls on Intel. The Motley Fool has a disclosure policy.

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