All seems right again for Nvidia Corporation (NADSAQ:NVDA) stock. NVDA stock tumbled last month, after “sell the news” trading following fiscal Q4 earnings and two analyst downgrades. The reaction was swift: Nvidia stock declined almost 20% in five weeks.
But Nvidia shares have regained a good chunk of their losses, increasing steadily since early March. The acquisition of Mobileye NV (NYSE:MBLY) by Intel Corporation (NASDAQ:INTC) highlighted the value of Nvidia’s opportunity in automotive.
Analysts from Goldman Sachs, B. Riley and UBS stepped up to defend the valuation of NVDA stock. In response, investors bought the dip in Nvidia shares.
It’s too soon to think the storm has passed for NVDA stock, however. Several risks remain for a stock priced at 32x FY17 consensus earnings-per-share. And investors would be wise to consider those risks — and the likelihood of another correction in Nvidia stock.
NVDA Stock: Not Everyone Can Win
At the same time Nvidia stock was rallying in 2016, so was Advanced Micro Devices, Inc. (NASDAQ:AMD). AMD actually outperformed NVDA stock in 2016, with AMD gaining 295% versus a 224% increase in Nvidia shares.
The optimism toward AMD comes from new products and a new ability to compete, driven largely by the Ryzen line. And there’s good reason for that optimism. But while AMD’s superior competitiveness will come mostly against Intel, AMD’s Polaris and Vega GPUs also make it a tougher competitor for Nvidia. Meanwhile, the backing of Mobileye’s technology with Intel’s scale, capital and connections makes a more fearsome competitor in automotive.
Neither end market is a zero-sum game, but at the same time, it seems like something has to give. Mobileye gets bought out for $15 billion. AMD is soaring. NVDA has soared. Are the opportunities in gaming and automotive really that much bigger than projected in 2015? Or are investor expectations starting to price in success for everyone, even though that’s not possible?
The latter explanation seems the most likely. And if those expectations change, the price of NVDA shares seems likely to fall as a result.
There Are Some Weak Hands Holding Nvidia Stock
There’s an “is the glass half-empty or half-full?” type of question regarding the recent trading in NVDA stock. Nvidia bulls might argue that the recent rebound shows that there remains a large number of investors willing to buy any dips in the stock. I’d argue the converse, however.
NVDA stock declined 20% — quickly — in what was then a rather bullish broad market, particularly for tech. And the catalysts for that decline weren’t particularly compelling. Q4 earnings looked strong, yet the market sold NVDA stock off. Then two analyst downgrades from smaller firms (Instinet and BMO Capital Markets) changed the narrative around Nvidia stock.
From here, that looks like a large group of investors willing to salvage profits after a big run, and a number of NVDA shareholders without a great deal of conviction in the bull case. And the 20% decline begs the question of what might happen if a true negative catalyst — like an earnings miss — comes into play. Even investors with a bullish long-term outlook on NVDA should consider the possibility of a more attractive entry point showing up in 2017.
The Story Behind NVDA Stock Isn’t That Great
When stocks rise sharply, the narratives around them tend to be reinforced — whether they should or not. Long investors are susceptible to “thesis creep” — re-writing the bull case to support continually higher upside. Wall Street analysts do the same.
Taking a step back, the Nvidia story seems a bit out of hand. Yes, the automotive opportunity is intriguing. But that end market accounted for 7% of total FY17 sales. Gaming growth is solid for now, but AMD is coming (and potentially pressuring pricing) and yearly growth rates will moderate.
NVDA has a market cap of $64 billion at this point and the drivers for further upside are getting smaller by the quarter. Even assigning the seemingly ludicrous 31x revenue multiple Intel paid for Mobileye to Nvidia’s automotive business would value NVDA’s auto business at about $21 billion. Nvidia stock has added that much paper value just since November.
In an upgrade this week, B. Riley called out the Nintendo Co., Ltd (ADR)’s (OTCMKTS:NTDOY) Switch gaming console as an upside catalyst for valuation. Again, Nvidia shares are worth $64 billion. Better-than-expected growth for Switch isn’t making a material dent in that valuation — it’s not like Switch is going to be released every year. If the Switch sells $1 billion more than expected, it’s probably worth $2 in NVDA fair value at most.
Nvidia is a great company, and a dominant market leader in gaming. But the semiconductor industry is tough; pricing falls over time, growth inevitably slows and the gap between high-end and low-end consistently narrows. NVDA is enjoying an upward cycle now, but those cycles inevitably turn. And when it does, it’s hard to believe that the narrative surrounding Nvidia stock won’t follow.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.