Nvidia Corporation (NASDAQ:NVDA), whose shares spiked 224% in 2016, has been lethal for short sellers. They lost a stunning $4.4 billion. And yes, it will probably still be bad for them to continue with their bearish bets on NVDA stock for the new year.
Now short sellers are some of the world’s best investors. If anything, they have to since the consequences of being wrong are so great! After all, a win for a short seller is if the stock goes to zero — which rarely happens. But as seen with Nvidia shares, the downside can be horrific.
The irony is that short positions can provide tremendous fuel for price appreciation. Keep in mind that short sellers need to buy back shares to close out their positions.
Something else to keep in mind: It’s generally not a good strategy to take a short position merely because the valuation is excessive. There are many examples of companies — like Microsoft Corporation (NASDAQ:MSFT) in the 1980s and 1990s, or Amazon.com, Inc. (NASDAQ:AMZN) during the past decade — that have sustained long bull runs. Wall Street is more than willing to place premiums on firms that can grow fast and with consistency.
As for NVDA stock, the valuation is definitely pricey. Consider that the forward price-earnings ratio is roughly at 42! By comparison, Intel Corporation (NASDAQ:INTC) trades at 12.5 and Qualcomm, Inc. (NASDAQ:QCOM) sports a multiple of 11.
But, of course, NVDA is growing at breakneck speed. So over time the multiples will normalize as the earnings continue to build up. For example, in the latest quarter, Nvidia reported a sizzling 54% spike in revenues to $2 billion and GAAP earnings came to 83 cents a share, up 89%.
The thing to keep in mind is that Nvidia is positioned nicely to benefit from various megatrends, which should provide lots of room for growth. The company’s deep experience with graphics processing units (GPUs), which allow for intensive computations, is becoming the elixir for cloud computing, artificial intelligence, virtual reality, self-driving cars and gaming. All these markets are massive and on the verge of major changes.
For example, according to a recent presentation from Nvidia, the market opportunity for autos alone is at least $10 billion. And the company may be in the best position to benefit. The company has built a full platform for so-called AI car computing — called Nvidia Drive PX 2 — that uses high-performance chips and software to detect surroundings as well as determine optimal routes. Actually, there are over 80 automakers that use the system, including Tesla Motors Inc (NASDAQ:TSLA).
At the core of all of Nvidia’s advantages in various large markets is the company’s focus on AI. For the most part, GPUs have proven adept at this type of advanced computing, which allow for trillions of deep learning transactions per second. The result is that a system can quickly adapt and learn. So, this means a self-driving car will know where to turn or stop. Or it could mean that a corporate cloud system has the ability to understand important trends or risks.
According to InvestorPlace’s Brad Moon:
“Because the GPU is designed for one primary purpose — everything including computer graphics boils down to crunching numbers — NVDA is able to produce them at far lower cost than a CPU at an equivalent performance level, while producing less heat and using less power.”
Great, right? Definitely.
Yet, this does not necessarily mean that the NVDA stock price will continue to rack up three-digit returns for years to come. No doubt, there will be lots of volatility. But again, when a company is at the forefront of tidal changes in technologies, taking a long-term bet often leads to nice market-beating returns.
Tom Taulli runs the InvestorPlace blog IPO Playbook and is a registered investment adviser representative (you can visit his site to learn more about his financial planning services). He is also the author of various books on investing like All About Commodities, All About Short Selling and High-Profit IPO Strategies. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.