Nvidia Corporation (NASDAQ:NVDA) has certainly been on a monster rally over the past year, rising nearly 200%. Nvidia is the best-performing stock in the S&P 500 over the past 52 weeks. In the past two years, the rise is well over 600%. Friday and yesterday both saw fresh all-time highs as NVDA stock broke out to the upside. While momentum can certainly take stocks higher, staying at these lofty levels is quite another thing. Now is an opportune time to take a look at NVDA stock from a more measured perspective.
The breakout rally was fueled by an Evercore ISI analysts upgrade on Friday. In the note, analyst C.J. Muse raised the price target from $180 to $250, citing a clear path to $10 in EPS over the next three to five years. Bank Of America Merrill Lynch followed suit yesterday with an upgrade from $185 to $210.
Let’s examine those assumptions made by Evercore ISI in a more quantitative and objective manner, using the new $250 price target in four years (midpoint of the three to five year time frame) and $10 of earnings. It is always critical as traders to examine price in a straightforward manner and not be swayed by momentum and emotion.
NVDA stock closed Monday at $187.55, so that leaves roughly $62.50 of upside, or 33%. That equates to just a 7.5% annual return for NVDA over the coming four years, certainly less than compelling when viewed through those optics.
Nvidia is also a higher risk/higher beta stock than average, so risk adjustments (similar to Sharpe ratios) need to be made. Factor in the higher level of volatility of NVDA stock and the 7.5% yearly return becomes even less attractive.
Assuming $10 in earnings in four years (which is certainly not a given) gives NVDA a 25 forward P/E ratio for 2021. Once again, not a compelling metric as a basis to be be jumping into a stock. The current NVDA P/E of 53 — nearly twice the five year average of 27 — also is at historically high levels that have been emblematic of tops in the past.
Although clearly breaking out to the upside past the $172.50 resistance area, NVDA stock is also getting extremely getting overbought. The 14-day RSI is now well above the 70 level, which has been a sign of short-term tops in the past.
While momentum chasing can certainly be a profitable strategy, it also carries heightened risk once the momentum inevitably wanes.
So rather than chase momentum here, let’s use the options market to get paid to wait and position to be a buyer at lower levels.
NVDA Stock Trade Idea
Buy NVDA Oct $170 puts and sell NVDA Oct $172.50 puts for a 50-cent net credit
Maximum gain is $50 per spread with maximum risk of $200 per spread. Return on risk is 25%. The short $172.50 put is structured at the support level and provides a 8% downside cushion to the $187.55 closing price of NVDA stock.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at firstname.lastname@example.org.