Nvidia Corporation (NASDAQ:NVDA) stock has pulled back sharply over the past few weeks. Nvidia stock hit an all-time closing high of $119.31 on Feb. 8. At that point, Nvidia had risen $370% in just a year, and was up nearly six times in the past 24 months.
Given the optimism toward NVDA, a reversal in that trend seemed highly unlikely.
Since then, however, NVDA stock has pulled back sharply — in a bull market, no less.
Nvidia trades more than 15% lower than it did barely three weeks ago. A modest selloff followed Q4 earnings in early February, despite numbers that came in well above expectations. Since then, a series of analyst downgrades and overall valuation concerns have pulled the high-flying stock back to Earth.
From here, the decline seems to make some sense. Nvidia has done a fantastic job of driving growth the past few years. Fiscal 2017 (ending January) revenue increased 55%; net income more than doubled. But valuation matters, too, and NVDA stock had reached at a point that in retrospect looks unsustainable.
With Nvidia still trading at 36 times FY18 consensus EPS, there could be more downside.
The NVDA Stock Bears Awaken
The first sign that NVDA was seeing valuation questions came after its Q4 earnings report early last month. The headline numbers in the quarter were hugely impressive. EPS of $1.13 beat estimates by 30 cents; revenue growth of 55% was more than four points higher than expected. In morning trading the next day, Nvidia stock cleared $120.
But it couldn’t hold those gains; shares wound up declining 2% on the day. Nvidia declined another 7% in the next session, with investors appearing to take profits after the huge bull run.
Two weeks after the earnings report, NVDA was rocked by two analyst downgrades:
- Instinet analyst Romit Shah cut the stock to “Reduce,” largely citing valuation concerns. Shah pointed to two previous product cycles — motherboard CPU in 2007 and the Tegra chip line in 2011 — which had driven similar optimism toward NVDA stock. In both cases, NVDA multiples had compressed. In this case, with Nvidia’s enterprise-value-to-sales ratio having jumped from 2x to 7x in just a year, Shah argued a similar, potentially dangerous, cycle was occurring.
- BMO Capital Markets added its own downgrade the same day, citing a “perfect storm” of fundamentals that had driven the stock higher. BMO’s target was actually lower than that of Instinet: $85 versus $90. The firm, like Instinent, highlighted valuation concerns, while also seeing tougher competition in 2017.
The combination of two somewhat rare “Sell”-equivalent ratings sent NVDA stock almost 10% in a single day.
Does the Bear Case for Nvidia Stock Hold Water?
Other analysts have come to Nvidia’s defense. Goldman Sachs maintained the stock on its “Conviction Buy” list. Mizuho & UBS both responded with “buy the dip” arguments. All three analysts set a target price for NVIDIA stock around $130, implying close to 30% upside from current levels.
But the downgrades clearly have made a dent in the narrative surrounding NVDA — and with good reason, I believe.
Valuation was stretched, with the stock at $120 trading at 40x 2017 EPS even excluding the company’s $8 per share in net cash. As strong as FY17 results were, Nvidia still is a semiconductor company. That’s a difficult, highly cyclical business, one where growth is difficult and multiples stay compressed.
Product cycles tend to limit long-term growth trajectories. Moore’s Law — and competition — both mean that prices generally decline over the cycle, pressuring margins and profits.
That’s why even growing chip makers tend to have low valuations. Both Cypress Semiconductor Corporation (NASDAQ:CY) and Mellanox Technologies, Ltd. (NASDAQ:MLNX) trade right around 14 times forward earnings. Intel Corporation (NASDAQ:INTC) is valued even lower, though it has some growth problems. (Instinet analyst Shah suggested investors swap INTC for NVDA, in part due to valuation.)
The pullback in Nvidia stock makes some sense, simply from a valuation standpoint. Even NVDA bears are forecasting some growth — it’s a question of how much, and at what price.
And competition isn’t to be ignored. Most notably, in automotive, Nvidia will go head-to-head with industry leader Mobileye NV (NYSE:MBLY). I think MBLY is overvalued, and similar over-enthusiasm may be boosting NVDA stock as well.
Simply put, growth will get more difficult for Nvidia going forward. That’s the nature of the semiconductor space. And slowing growth isn’t priced into NVDA stock — even after the 15% pullback.
How to Play NVDA From Here
At this point, Nvidia looks more reasonably valued — even if I think it’s a bit overpriced.
A short of Nvidia stock seems too aggressive at this point, to be sure, but a long play might be too early. It seems likely that NVDA will be a battleground for the next few months, with bulls and bears arguing over the outlook. That will drive some volatility, but likely not much in the way of movement.
I’d think bulls and bears alike might consider letting the dust settle here, particularly until first-quarter earnings in May. Both sides make some good points, and both sides will continue to make those points.
I doubt either the bulls or the bears will make much progress, however, until at least the next earnings report.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.