Like many American stocks, all appeared to be well for Nvidia Corporation (NASDAQ:NVDA) through Tuesday. NVDA stock had just traded to a new all-time high. Following a blockbuster earnings report, the stock shot up. It appeared that bulls had complete control.
Then, the Trump political drama hit.
The Dow plunged 372 points Wednesday, and the S&P 500 saw a similar 1.8% decline. And the tech-heavy Nasdaq Composite led the way. It plunged 2.6% on the day. Wednesday brought the market its heaviest losses since last September.
Investors didn’t spare NVDA stock; in fact, it was among the heaviest losers. It dropped $9 per share, or 6.6% on the session.
Now the question is clear: Was Wednesday’s drubbing just a one-day anomaly? Or will the huge decline lead to a broader correction in NVDA stock? Let’s examine the pros and cons for Nvidia stock here.
NVDA Stock Cons
Increasingly Bubble-like: As InvestorPlace contributor Dana Blankenhorn warned recently, Nvidia stock is looking more and more like a bubble. Blankenhorn makes the comparison to Amazon.com, Inc. (NASDAQ:AMZN) in 1999. Like NVDA today, Amazon then was a fast-growing company with nearly unlimited potential. Yet, Amazon traded at such a ridiculously high price that it would take the company’s stock a decade to reach new highs from its dot.com bubble peak.
Nvidia, similarly, has run six-fold in less than two years. Its stock is trading at a nearly unheard of 45x earnings. That’s simply unprecedented for a semiconductor firm. While the whole sector is booming, other strong players with self-driving auto ambitions such as Texas Instruments Incorporated (NYSE:TXN) trade at just 22x earnings. And even that is expensive by typical sector standards.
How Much Are the Newer Businesses Worth? A good chunk of the recent earnings upside at Nvidia has come from gaming. However, NVDA has long been a gaming-focused company, and it historically traded around 3x enterprise value/revenues. This ratio has now exploded to 11x.
Bulls will suggest that this is justified by the autos and data centers business. However, there are other semiconductor companies involved in both of those sectors, and nobody is trading near 11x enterprise value/sales either. Texas Instruments, with its surging autos business and moat-heavy analog chips core, sells for 5.5x EV/sales. Sure, Nvidia may have somewhat more exciting growth prospects, but it’s a tough stretch to say it’s worth twice as much on multiple valuation metrics as a solid competitor.
Vulnerable to Broad Market Sell-off: As Wednesday showed, when the stock market goes down, NVDA stock gets pummeled. This is for a simple reason. Nvidia stock is extremely popular with momentum traders, algos, hedge funds and other such hot money shops. These sorts of traders tend to use a lot of leverage and will dump stock as soon as it stops going up.
Wednesday afternoon, we saw many heavily shorted “old economy” stocks such as mall real estate investment trusts shoot up, while popular tech stocks slumped. It appears that the trade of buying tech and banks and selling virtually everything else may be drawing to a close. Trump was supposed to cut corporate taxes and allow tech companies to bring cash home. This powered a huge run in the Nasdaq. But if Trump loses more political steam, look for NVDA stock to remain weak as investors dump tech.
NVDA Stock Pros
Huge Earnings Report: Nvidia stock absolutely exploded to the upside on earnings last week, rising as much as 30%. That may seem excessive; however, the numbers make a strong case for such a move.
NVDA managed to grow revenues a stunning 48% this quarter versus the same one last year. Even more impressively, the company turned that revenue growth into a sparkling 144% increase in net income. Despite heavier share dilution than you’d like to see, it still turned this into 85% earnings-per-share growth. While it is hard to justify Nvidia’s current valuation multiples, you can’t fault the company’s recent growth track record.
Diversifying Revenue Streams: As mentioned above, the market didn’t value NVDA stock all that highly when it was a mostly pure-play gaming outfit. If the market returned to pricing the stock at 3x EV/sales, as it historically did when it was a gaming company, Nvidia stock would have massive downside.
Fortunately, while gaming revenues are still growing sharply, other revenue streams are also coming online. The first of these is auto, which has doubled over the past eight quarters, reaching $140 million in the most recent. This isn’t a huge growth rate, at least not yet. But auto is a high-value market and the company’s R&D may be planting the seeds for much bigger upside later.
More impressively, data center is absolutely booming. Eight quarters ago, Nvidia brought in just $72 million in data center revenues. This has more than quintupled to $409 million in the most recent quarter. As a percentage of the business, data center is up from about 7% then to 20% of revenues today. Given the never-ending growth of the cloud, NVDA has a huge market opportunity to address here.
Momentum May Return: As I discussed in the cons, Nvidia stock is volatile and could be exposed to more downside if the market declines. However, the U.S. market remains in a strong bull on a technical basis. It seems relatively unlikely that some political drama would end an eight-year bull market. The S&P made fresh new all-time highs on Tuesday, and NVDA stock did with it. This could well just be a short-term blip.
Assuming the market brushes off this latest disturbance as it has Brexit, Trump’s election night surprise and numerous other such events, Nvidia stock should recover and move to fresh highs. NVDA is one of the market’s leaders, and momentum traders will come back if the market bounces here. Additionally, the stock appears to have strong technical support around the $120-level, limiting risk for shorter-term traders.
Bottom Line on Nvidia Stock
For investors that missed Nvidia’s huge earnings run, this could be a second chance. NVDA stock got slammed on Wednesday, and it wasn’t the company’s fault specifically.
However, be very careful with Nvidia stock here as anything other than a short-term trade. There are mounting signs of a potential bubble here. NVDA has created massive growth expectations, and even a small hiccup would likely send shares spiraling far lower.
At the time of this writing, Ian Bezek owned TXN stock and had no position in NVDA stock. You can reach him on Twitter at @irbezek.
