Most of the news about Nvidia Corporation (NASDAQ:NVDA) stock these days seems to be about its big move into artificial intelligence. Of course, I could say the same thing about a lot of other tech companies right now including competitors such as Advanced Micro Devices, Inc. (NASDAQ:AMD).
At 55 times its trailing-year earnings and 14 times its 2016 sales, InvestorPlace writer Dana Blankenhorn is right to wonder if NVDA stock has gotten ahead of itself.
In Blankenhorn’s July 18 article about Nvidia, he suggests that although AI has made it something much bigger than just a “graphics” company, it’s priced as if it has a monopoly on artificial intelligence when, in fact, it isn’t close to having the market to itself.
Translation: NVDA stock is priced for perfection!
When I last wrote about Nvidia, I looked at whether it was time to sell NVDA stock. Although expensive, I argued that business is too good at the moment for investors to get off the momentum bus.
“Next stop, $200,” I wrote.
Since then Nvidia stock is up 8.7% through July 25, just 20.5% away from $200. Frankly, unless we have some kind of mystery correction or financial calamity, I can easily see this happening by Thanksgiving.
It’s All Relative
Is NVDA stock expensive? Absolutely. Its price-to-sales ratio is seven times the S&P 500. I don’t think there’s any argument it’s pricey.
But, as the headline states, it’s all relative. Bear with me as I explain.
Perhaps you’ve heard the news: McCormick & Company, Incorporated (NYSE:MKC), fondly known as the spice people, are buying the food business of Reckitt Benckiser Group Plc-ADR (OTCMKTS:RBGLY) for $4.2 billion, bringing French’s mustard and Frank’s hot sauce into the fold.
Analysts are surprised at the price Reckitt Benckiser obtained for its food business — more than seven times sales and 20 times EBITDA, according to Reuters. But, there’s more to this acquisition than meets the eye.
“The price tag of £3.2bn [$4.2 billion] is staggering,” Philip Gorham, an analyst at Morningstar, is reported to have said according to the Financial Times that the price achieved — which was well above initial estimates of £2bn [$2.6 billion] — “must, in our opinion, be the result of a competitive bidding process, which is perhaps not surprising, given that these are solid brands in their respective niches.”
You Pay More for Quality
In recent years, the typical M&A deal in the food business has seen buyers pay an average of 3.3 times sales and 16.2 times EBITDA, according to data from Bernstein Research. Based on those metrics, MKC overpaid by as much as 67%.
McCormick’s CEO, Lawrence Kurzius, doesn’t see it that way. He explained:
“The acquisition of RB Foods strengthens McCormick’s flavor leadership with the addition of the iconic French’s and Frank’s RedHot brands to our portfolio, which will become our number two and number three brands, respectively. The addition of Frank’s RedHot Hot Sauce, the clear consumer favorite in an attractive and high-growth category, French’s Mustard and the other beloved products enables McCormick to become a one-stop shop for condiment, spice and seasoning needs.”
As Warren Buffett always says, “Price is what you pay. Value is what you get.”
Reckitt Benckiser was never going to keep its food business after completing its purchase of Mead Johnson Nutrition in June. Never. MKC had the opportunity to snag a couple of excellent brands that complement its existing lineup, while keeping them out of the hands of the competition.
I’m not a fan of leverage — net debt to EBITDA increases to 4.1 from 3.3 — the ability to kill two birds with one stone seems too good to pass up. If you own MKC stock, I’d be buying more on the market’s negative reaction.
Bottom Line on NVDA Stock
Nvidia’s fiscal 2017 free cash flow was $1.5 billion, or 22% of its annual revenue. McCormick’s free cash flow was $658 million or 15% of its annual revenue.
If McCormick is willing to pay seven times sales for a business that likely doesn’t generate free cash flow equal to or greater than 15% of its annual revenue, Nvidia shareholders paying 14 times sales is the price you pay to own a business that generates 50% more free cash flow relative to annual revenue.
As I said, NVDA stock isn’t cheap, but with the future looking bright, on a relative basis you could do a lot worse.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
