It seems the only thing that can stop Nvidia Corporation (NASDAQ:NVDA) stock from climbing higher is Wall Street’s outrageously high expectations. While that can be a great problem to have in the long term, NVDA stock, in this case, has fallen victim to its own string of successes, which lead to such a strong belief that it can never do any wrong.
In that vein, NVDA shareholders have every reasons to be frustrated, watching NVDA stock fall more than 7.5% following its August 10 earnings reports despite the semiconductor giant not only beating analysts’ second quarter estimates on both the top and bottom lines.
The graphics chipmaker also issued guidance above Street forecasts. Some pundits argued, however, that the company’s forecast — despite topping estimates — could have been “rosier” to support the stock’s valuation.
Ahead of the quarter, NVDA stock traded at about 45 times forward earnings, compared to a forward P/E of 19 for the S&P 500 Index. While that valuation would, understandably, keep NVDA stock out of the bargain bin, especially compared to Intel Corporation (NASDAQ:INTC) and Advanced Micro Devices, Inc. (NASDAQ:AMD), the price tag is nonetheless reasonable when you factor in that NVDA is growing EPS north of 40% every year. Meanwhile, this compares to 10% projected growth for Intel while AMD is looking to reverse last year’s 14 cents a share loss.
To that end, it’s tough to raise the valuation argument against NVDA, especially given the company’s solid — albeit conservative — forecast. For the fiscal third quarter, the Santa Clara Calif.-based company expects revenue to come in at $2.35 billion, give or take 2%. This would translate to 17% year-over-year increase (at the midpoint) and $120 million above the second quarter.
NVDA Is Just Being Conservative
Why did NVDA stock sell off? The market got spooked by the fact that 17% projected revenue growth would mark a significant deceleration from Q3 2016’s 54% growth. Not to mention, the third quarter is often a seasonally stronger quarter for the company. It didn’t matter that NVDA projected adjusted gross margins to be 58.8% — give or take 50 basis points — which is not only above Street estimates, but it would be above Q2 gross margins of 58.4%.
From my vantage point, NVDA is just being conservative with its third-quarter guidance. Management likes to throw around the “give or take 2%” qualifier, which in the most recent quarter turned out to be another double-digit beat. The company reported second-quarter EPS of $1.01 on revenue of $2.23 billion, crushing analysts’ profit estimates by 31 cents, while topping revenue expectations by $270 million.
On a segment basis, NVDA’s bread-and-butter GPU unit posted revenue of $1.9 billion, which surged almost 60% year over year on the strength of the better-than-expected Tegra processor sales, which reached $333 million — more than two times last year’s total. Recall, the second-quarter guidance offered back in May also included the “give or take 2%” qualifier.
Yet, here we are, a few weeks after NVDA delivered record revenue of $2.23 billion — growth of 56% year over year from $1.43 billion a year earlier, while climbing 15% from $1.94 billion in the first quarter.
Investors should also focus on the company’s large pile of cash, which now stands at $3.8 billion after management used $758 million to buy back shares and paid out $166 million in dividends.
From High Revenue Growth to High Value
To that end, while Nvidia’s revenue may be — as one would expect — slowing from nose-bleed levels, investors should embrace the company’s improved cash position. NVDA announced plans to return some $1.25 billion in cash to shareholders in fiscal 2018 via a combination of quarterly cash dividends — currently 14 cents per share — and share buybacks.
What’s more, investors should be encouraged by the fact that as the chipmaker’s profits continue to rise, while revenue growth stabilizes, the NVDA — unlike, say, Intel — doesn’t need any additional blockbuster deals to grow the top line. That increased cash will allow NVDA to grow its dividend over time, and support the valuation and EPS with timely stock buybacks.
Bottom Line on NVDA Stock
Investors who have waited patiently on the sidelines for a better entry point in NVDA stock should embrace this as a solid buying opportunity. While the forward P/E of45 seems rich, the Q2 earnings beat of 31 cents underscores how much NVDA is being underestimated in terms of its pricing power and gross margins, which are still rising. As such, I now have a 12-18 month price target of $210, up from $200. The raise assumes additional premiums of 28%, driven by growth in the data center, automotive and gaming segments.
As of this writing, Richard Saintvilus did not hold a position in any of the aforementioned securities.