Inarguably, 2016 was the year of the semiconductor. Once heavily blasted due to industry-based tailwinds, demand kicked back up, sending Nvidia Corporation (NASDAQ:NVDA) to the moon. Even better, disastrously embattled companies like Advanced Micro Devices, Inc. (NASDAQ:AMD) and Micron Technology, Inc. (NASDAQ:MU) got their “mojo” back. Naturally, expectations were high going into the new year.
Unfortunately, the markets have not cooperated with chipmakers in general. On a year-to-date basis, NVDA stock is down nearly 4%, a sharp contrast to last year’s 233% joyride. The quick counterargument to the bearish naysayers is that all rallies need to be consolidated. The most powerful rocket ships still need to refuel. Otherwise, even ardent proponents will become fearful of an unsustainable bubble.
Yet, any apprehension toward NVDA stock at this juncture is understandable. On one side, investors are “happy” that they’re not AMD shareholders. AMD stock has tumbled to -11% YTD due to its first-quarter earnings slaughter. In contrast, MU is showing the competition how it’s done, with 28% YTD gains.
Regret is a powerful emotion, especially in the financial markets. With such a sharp contrast among the major semiconductor players, it’s tempting to jump ship from Nvidia stock. Is there a reason to stay onboard with NVDA?
Creeping Doubts About NVDA Stock
Although I believe the answer is yes, the reasonable investor will acknowledge the risk factors. As InvestorPlace writer Tom Taulli notes, they are significant.
First and foremost, Nvidia has a business allocation risk. The company generates a vast majority — as in 84% — of its top-line sales from its graphics processors. That’s fine and dandy when the industry is surging. When it’s not, however, problems arise.
Taulli writes that “two of the world’s largest PC motherboard operators have reported lackluster shipments in Q1. Keep in mind that NVDA has already been slashing the pricing on its GTX 1080.”
Secondly, competition is always a concern. In the technology sphere, one seemingly inconsequential misstep now could create exponential problems later. Taulli is absolutely correct in his earlier assertion that sector demand is pressuring semiconductors. I raised the issue that the producer price index for semiconductors is declining, while production is rising. In that eroding environment, only the strongest will survive. Logically, investors and analysts will ask whether Nvida stock belongs on that list.
Furthermore, the smart car sector is becoming heated. Acquisitions and proposals involving NXP Semiconductors NV (NASDAQ:NXPI) and Mobileye NV (NYSE:MBLY) have upped the ante substantially. The obvious risk here is that “super-companies” can out-muscle Nvidia.
Finally, Taulli does not like the skyrocketing valuation of NVDA stock. At a price-to-earnings multiple of 41x, better options are available. When you combine the fact that semiconductors are inherently volatile, some analysts find it difficult to justify the premium.
Nvidia Is Healthier Than You May Think
Now that we’ve gotten the bad news out of the way, let’s consider the positives. On a valuation scale, NVDA stock is neither here nor there. Plenty of companies run high P/E ratios, but that doesn’t make them terrible investments. Many run low P/E ratios, but they aren’t great picks, either.
The extreme leverage toward the GPU market and the broader competition is a bit trickier. I will humbly suggest, however, that the prime growth markets for Nvidia stock are in no danger of waning. For example, the smart car revolution is not just about driver conveniences. Both the U.S. and international organizations established clear automotive safety targets. This equates to more demand for companies like NVDA, not less.
In addition, organizations inspired by the success of Tesla Inc (NASDAQ:TSLA) may want in on the smart car pie. Even speculative endeavors like flying cars will, more than likely, incorporate smart technologies. Again, I just see the market increasing for innovative NVDA stock, as opposed to shrinking.
The excess leverage issue is a problem if the only thing the company does right is still a stinker. Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) is “just” an online telemarketer, yet I don’t see too many folks complaining. As a well-established industry leader, I wouldn’t get too uptight about Nvida stock.
Ultimately, NVDA is disappointing because it has to be. The company had a phenomenal run the likes of which has not been seen since 2001, when shares returned 347%. So, a correction is more than warranted, perhaps even deserved, if you will. I would actually be more worried if Nvidia’s run continued unabated.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.