When everything is going right for a growth stock, that’s when things get dangerous. Consider Nvidia Corporation (NASDAQ:NVDA). NVDA stock has gained nearly 700% just since the beginning of 2015, including more than 450% from early 2016 lows.
Analysts are boosting price targets left and right. Even Pacific Crest, whose downgrade of NVDA stock sent shares tumbling in April, upgraded the shares recently. A stock that fell hard earlier this year on downgrades from smaller firms now is a Street darling.
Everything seems to be going Nvidia’s way at the moment. A spike in the price of Bitcoin and Ethereum cryptocurrencies has boosted shares of NVDA and Advanced Micro Devices, Inc. (NASDAQ:AMD). Graphic processing unit sales are benefiting from demand for ever-better gaming rigs.
And autonomous driving optimism has boosted Nvidia and Tesla Inc (NASDAQ:TSLA), among others, while also leading to Intel Corporation’s (NASDAQ:INTC) $15 billion purchase of Mobileye NV (NYSE:MBLY).
That torrent of good news has led to a nearly 60% run in the NVDA stock price just since early May. But a sky-high valuation — and questions about what exactly is left to be priced in — means Nvidia might need to take a breather as its market cap closes in on a stunning $100 billion.
Short-Term Drivers for Nvidia
One concern about the frenzy for Nvidia stock has to be that some of the profit drivers here are relatively short-term. GPU demand likely will remain intact for some time. But expecting successive repeats of Q1’s 45% growth seems aggressively optimistic.
The same is true for the cryptocurrency boom or bubble. Ethereum prices already are pulling back. Both AMD and Nvidia saw similar demand drive sales in late 2013 and early 2014 — which proved to be a short-term peak. Both firms should benefit in their Q2 and Q3 results from the spike — but inventory build will likely limit the impact by Q4.
Obviously, both autonomous driving and data center chips offer huge opportunities for long-term growth. Still, Nvidia generated just $1.3 billion in revenue in those two categories in FY17. Even with data center revenue tripling in Q1 and automotive industry sales rising 24%, the company is looking at less than $3 billion in FY18 revenue from the two categories combined.
Again, this is now a company worth nearly $100 billion. Plus, it’s not a guaranteed winner in either space, even if prospects do look rather rosy at the moment. Meanwhile, more than half of Q1 revenue still came from gaming, and another ~8% from the declining OEM & IP business. I thought Q1 earnings were fantastic and turned bullish on NVDA stock as a result.
But the stock now trades near $160 — up another 30% after an already-impressive 18% post-earnings gain. Expecting the $2 billion-$3 billion automotive and data center businesses to add another $10-20 billion in market cap on their own seems like it might be too optimistic.
What Changes The Sentiment Toward Nvidia?
That hardly means NVDA stock should be shorted. Indeed, those who have — including well-known short-seller Citron Research — have paid dearly for their decisions.
However, it’s worth wondering whether NVDA stock can handle any change in sentiment at this point.
It was just four months ago that the stock dropped ~20% largely due to two downgrades from firms (BMO and Instinet) that generally don’t have the power to move such as well-covered, widely-owned stock. NVDA now trades at 11x FY18 revenue estimates — 11 times sales! — which is likely an unprecedented multiple in the often low-margin chip space.
It’s a valuation that is incorporating ever-better news and that seems a bit dangerous, at least from a short-term standpoint. What, exactly, will Nvidia earnings in August have to look like to push the stock higher? What happens the first time an analyst decides to break from the pack and question NVDA’s valuation?
For investors with a long-term horizon, those questions might not matter. Continued success in automotive and data center, combined with the legacy dominance in GPUs, should allow NVDA stock to generate quality returns over time.
For investors not yet long Nvidia, however, it’s worth considering whether a better entry point might be on the horizon. And for traders aggressive enough (or perhaps crazy enough) to bet on a short-term pullback, it seems an intriguing opportunity.
After all, there’s a lot of good news surrounding NVDA stock at the moment — and little in the way of bad news. Investors might do well to remember that contrarian investing doesn’t only happen for stocks at the bottom. When the sky seems the limit for a stock, quite often that’s when a roadblock emerges.
The way Nvidia is going, and the way its shares are valued, at this point such a roadblock wouldn’t be much of a surprise.
As of this writing, Vince Martin has no positions in any securities mentioned.
