- Shares of Advanced Micro Devices, Inc seemed to have bottomed out for now.
- In the long run, AMD's proposed debt restructuring will aid the company's financial health.
- The AMD stock still carries a significant bankruptcy risk.
Shares of Sunnyvale, California-based Advanced Micro Devices, Inc. (NSDQ:AMD) have generated fabulous returns for investors over the last twelve months, gaining by nearly 200%. With the shares now down about 25% from its peak, investors who have been sitting on the sidelines might be tempted to get in. Even more so, given the positive impact of AMD's proposed debt restructuring. While AMD shares appear to have bottomed out for now, conservative investors would do well to stay away. AMD shares still carry a substantial bankruptcy risk. Here's why.
Quantifying The Risk
Often, subjectivity clouds our assessment of risk. So, let's take an objective approach, since there is one. To begin with, let's look at the value of what you own if you buy AMD shares.
Shareholders' Equity And Why It Matters
The value of shareholders' equity represents the amount that would be returned to shareholders after all the company's assets have been sold, and lenders repaid, in the event of a bankruptcy. A negative shareholders' equity value means that equity investors get nothing. They have no residual claim.
Until a few days ago, AMD's shareholders' equity value stood at a negative $413 million. Now that AMD has raised $600 million ($580 million net of expenses) worth of equity, the value of that residual claim amounts to $103 million.
Now, AMD has 895 million shares, implying a residual value of 11 cents a share that costs $6. That stands in contrast to a residual value of $13 a share for a ~$36 Intel share. That's not to say that Intel is a great investment based on that figure alone. The comparison is made purely to illustrate the greater degree of safety investors enjoy when investing in financially stable companies.
Of course, the risk/reward is likely to be very different. Shares of a company like AMD are likely to react much more to positive triggers, which is something the near 200% rally over 1 year illustrates. But to really understand the degree of risk and likelihood of bankruptcy, the Altman Z-Score is one of the tools investors can use.
Quantifying The Risk Of Bankruptcy
The Altman Z-Score is a credit strength test that's tailor made for this situation. The Altman Z-Score is a test that investors can use to assess the likelihood of bankruptcy for a publicly listed manufacturing company, and factors in aspects like profitability, leverage, liquidity and solvency.
To arrive at the Z-score, one needs to calculate 5 business ratios, which are then assigned predefined weights and summed up to arrive at the final score. These 5 ratios and their weights were identified and predefined by NYU Stern Finance Professor Edward Altman back in 1967, based on his study of patterns with bankrupt firms.
A company with a score of 3 or above is considered to be in the safe zone, while a company with a score of less than 1.8 is seen as one that's probably headed for bankruptcy.
The formula is, Z-Score = 1.2A + 1.4B + 3.3C + 0.6D + 1.0E, where A to E represent the 5 business ratios and their coefficients represent the weights.
The 5 business ratios are as follows:
A = working capital/total assets
B = retained earnings/total assets
C = earnings before interest and tax (EBIT)/total assets
D = market value of equity or market cap/total liabilities
E = sales/total assets
All the data required is available in AMD's last 4 10-Q filings, so all you have to do is find these numbers in AMD's SEC filings. I've used trailing twelve months figures for EBIT and sales. The numbers we need are as follows.
|AMD Financials||$ - Billions|
|AMD Working Capital (Current Assets - Current Liabilities)||0.93|
|AMD Total Assets||3.32|
|AMD Retained Earnings||-7.35|
|AMD EBIT (TTM)||-0.28|
|AMD Market Cap||5.21|
|AMD Debt (short and long term)*||3.15|
|AMD Sales (TTM)||3.88|
*Assuming $580 million worth of equity is used for repayment of debt
Based on these numbers, AMD's Altman Z-score stands at -0.89. That's an improvement over a score of -1.04 prior to the fund raising and proposed debt restructuring. But it's evident that AMD shares still carry a high bankruptcy risk.
For the sake of illustration, Intel's Altman Z-score is 3.61. Again, that's not to say that Intel is a good stock to buy based on this one number alone. Rather, the Altman Z-score is a useful tool that tells you what NOT to buy. It's a filter investors could use to eliminate options.
There's no element of subjectivity here, which has its advantages and disadvantages, because stocks are also driven by qualitative aspects that impact the company. However, it's clear that the AMD stock is not a good investment option for conservative investors. At least for now.
Summing It Up
The AMD stock has generated superb returns for investors over the last one year, gaining by nearly 200%. Investors who have missed out on the rally might be tempted to consider buying the stock, now that it has seen a sizeable correction of about 25%. Even more so, given the positive impact of AMD's proposed debt restructuring.
Shares of AMD seem to have bottomed out for now. However, conservative investors would do well to avoid the stock for now, given the significant bankruptcy risk it still carries.