Nvidia Corporation (NASDAQ:NVDA) shares are heading lower following Thursday’s fourth-quarter report — and it seems like this was the only possible result. Even outstanding results were never going to be enough to lift NVDA stock after a rip-roaring 340% gain in a year.
But Nvidia at least gave Wall Street something to think about.
Traders and analysts spent a lot of time hedging their bets heading into this one. Earnings expectations for Q4 — even the whisper number — saw only small improvement from the Q3 blowout, when sales rose from $1.4 billion to over $2 billion and profits nearly doubled, to 83 cents per share.
It seemed the optimists would be happy with 87 cents of earnings on revenue of $2.11 billion, and content themselves with comparing the December results with those a year earlier.
The question was whether that was worth a valuation of more than $60 billion — about 7.5 times revenue and a whopping 60 times earnings. The technicals did not look good, either.
So during the week before earnings, NVDA stock mostly sold off, giving up $2.50 off a high of $120.20. The hope was to build a base to test the highs if expectations were met, and an excuse for picking up “a bargain” if the miss was small.
This Pullback in NVDA Stock Was Expected
Those hoping for a pullback after earnings got their wish, but Nvidia was hardly at fault.
On a day when even beating estimates soundly wasn’t enough to save the stocks of Pandora Media Inc (NYSE:P) and Yelp Inc (NYSE:YELP), Nvidia stock fell despite posting spectacular earnings of $655 million, or 99 cents per share, on revenue of $2.173 billion. These numbers handily beat the whisper on earnings, but just narrowly beat it on sales. Gross margins of 60% were even better than the previous quarter’s 59%.
For the year, this meant net income of $1.666 billion ($2.57 per share) and revenue of $6.910 billion, meaning profits rose 171% over the year before, on 38% more revenue.
NVDA stock was off about 3% after the numbers came out, following a 2% decline during Thursday’s regular session.
The company’s conservative outlook may have been why the stock fell at all. For the coming quarter, Nvidia expects revenues of just $1.9 billion.
Nvidia’s Next Act is Virtual
Analysts agree Nvidia is due to grow, because it leads its markets and those markets are growing. The question is how fast this is happening, and where.
NVDA bulls at Saxo Bank believe the big hit to revenue came from data center contracts, a deal signed last year with Alibaba Group Holding Ltd (NYSE:BABA) to build high performance clouds in the Chinese market. The result was a 121% increase in datacenter revenue during 2017.
This dwarfed the gain in gaming, but gaming still represented two-thirds of revenue, the bank said. Nvidia remains, at heart, a gaming hardware company.
When Digi-Capital estimated the virtual reality and augmented reality markets last year, they saw $120 billion in potential sales by 2020. Other market estimates were even more optimistic, and this was before the excitement over Pokemon Go, virtual reality headsets plugged into smartphones, and self-driving cars really got going.
Now, iGate Research sees a $40 billion market in 2020, with entertainment hardware leading the way. But that big hit to revenues is supposed to fade away quickly with long-term growth settling down to 10.3%.
If gaming represents the bulk of revenue, then, and gaming hardware growth is slowing, should you really expect NVDA stock to justify that price earnings multiple of 62?
The early answer was no, but don’t expect the stock to stay down for long.
Dana Blankenhorn is a financial and technology journalist. His latest novel is Bridget O’Flynn vs. Something Big & Ugly. Write him at email@example.com or follow him on Twitter at @danablankenhorn. As of this writing, he was long BABA.