In the spirit of full disclosure, I readily admit I am not a momentum trader. I have never quite been able to grasp the concept of paying more for something simply because it is going ever higher. Not to say that momentum trading isn’t profitable. All one needs to do is look at the last few weeks of price action in certain stocks to witness one of the great momentum runs in recent history.
Nvidia Corporation (NASDAQ:NVDA) has been the poster child for momo names. Yesterday’s breakout to new all-time highs looks like it’s fueling even more buying in NVDA stock.
Being a contrarian can be a lonely job, especially in a red hot stock like Nvidia. But words of caution are always most needed when things get a little too hot. NVDA may continue screaming ever higher and I will be the wet blanket on the Nvidia party. But here are three things you may want to consider (but probably won’t) before jumping onboard the momo train in NVDA stock.
Technicals
Click to Enlarge While NVDA stock did break out to fresh all-time highs past the $147 area, it remains extremely overbought on a 14-day RSI basis with a reading approaching 75. Nvidia is also trading well outside the 20-day moving average envelope (which encompasses plus or minus 10%). In the past, this has been a reliable indicator that caution may be warranted.
Investorplace contributor Johnson Research Group adds further illumination to the potential bearish technical set up in a well-researched article from yesterday regarding NVDA stock.
Nvidia was the best performing stock in the S&P 500 in 2016 according to our own Executive Editor Jeff Reeves with an astounding gain of 198%. So far in 2017, NVDA stock has risen an additional 40% more. Call me a curmudgeon, but Nvidia may be getting a little overheated from a price perspective … and at some point, price actually does matter.
Nvidia’s Valuation
NVDA stock closed yesterday with a price-to-earnings ratio exceeding 50, by far the highest level over the past several months. This compares to a five-year average P/E ratio of 25.3, so NVDA is now being valued at twice the norm. Consensus 2019 earnings for Nvidia are $3.47 a share, meaning NVDA stock is now trading at over a 40 forward P/E ratio. Certainly at the nosebleed level to say the least.
The highest earning estimate for 2019 comes in at roughly $4.00 per share. Putting the five-year average 25 P/E multiple on those $4.00 per share earnings gives a 2019 valuation of $100 per share for NVDA, or a 32% discount to the closing price of $148.01. Future earnings growth better be explosive to justify current valuations.
Analyst Estimates for NVDA Stock
According to the Wall Street Journal, the median consensus estimate of 38 analysts for NVDA stock is $124 per share with a high of $165 and a low of $44. The Financial Times paints a similar picture, showing a $125 median with a $165 high and $75 low based on 33 analysts.
Most analysts point to the slowdown in gaming revenues, which still account for nearly 60% of Nvidia’s overall revenue, as the reason for a below market price target. The infatuation with new ventures by Nvidia into such buzzworthy areas as “artificial intelligence” and “autonomous driving” seems to be the main driver behind the recent run up in NVDA stock.
Even assuming the high price target of $165 per share for Nvidia is correct, that is only 11% upside for NVDA stock from the $149 level. For a stock that has risen so far, so fast, one has to wonder at what price the reward is still worth the risk.
With NVDA stock trading at the highest price and nearly the richest valuation ever, some traders may want to pause and consider how much more upside NVDA stock has left, even given the impetus of the breakout to new highs. Momentum traders that are simply following price may elect not to pay any heed … and they may prove to be correct. As John Maynard Keynes aptly said, “Markets can remain irrational longer you can remain solvent.”
But don’t say you weren’t warned.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at tbiggam@deltaderivatives.com.
