NVIDIA Corporation (NASDAQ:NVDA) stock is on fire. As the stock surges higher, sell-side analysts are concurrently raising their price targets, saying there’s even more upside to NVDA stock, which has already risen about 1,000% over the past 3 years. The bulls keep saying the addressable market is really, really big, and that secular tailwinds supporting NVDA’s business are really, really strong.
They are right.
But NVDA won’t run in open fields forever. Competition from Advanced Micro Devices, Inc. (NASDAQ:AMD) and Intel Corporation (NASDAQ:INTC) is sure to intensify over time. That will inevitably erode NVDA’s sky-high growth rate. When the growth rate comes down, so will the valuation.
None of this is to say NVDA stock is currently overvalued, but it is to say that while I’m still long NVDA, I am aware that the valuation is starting to max out. I think NVDA stock is fairly priced at $225/share.
Here’s how I get that number…
NVDA Stock & the $225 Level
I’m at risk of sounding like a broken record, but NVDA is exposed to every part of the market growth investors want exposure to. We are talking artificial intelligence, machine learning, autonomous driving and data centers — just to name a few. Each of these markets has huge growth potential and, right now, NVDA is the clear leader in all of these markets.
Inevitably, as time goes on and these markets scale, NVDA will be subject to ever-increasing competition. Whether it comes from current competitors like AMD and INTC or a brand new competitor remains to be seen, but you can guarantee that competition will stiffen. Greater competition and maturing markets will slowly cause NVDA’s sky-high growth rate to erode.
Earnings per share rose 83% last year. They are growing at roughly the same clip so far in fiscal 2018. But these 80% to 90% growth rates won’t last forever. Again, due to competition and the law of large numbers, these growth rates will come down dramatically over time.
Investment firm RBC is out with an interesting note, which distills the NVDA bull case to $10 earnings per share by fiscal 2021. This would represent roughly 35% earnings growth per year into 2021 from fiscal 2017’s $3.06 earnings base.
I am very comfortable with that compounded annual growth rate.
So, lets say NVDA does net earnings of $10 per share in fiscal 2021. If so, growth at that point will likely look something like 20% to 30%. What sort of multiple will that growth profile be awarded in 2021? I think a 30 multiple seems about fair for roughly 25% growth.
A multiple of 30 on $10 EPS implies a 3-year price target of about $300. Discount that back by 10% per year, and you get to a current fair value of about $225 on NVDA stock.
Bottom Line on NVDA Stock
I have been an NVDA bull for a while, but that doesn’t mean I think this stock will rise forever.
I think it’s very reasonable to project a 35% annualized earnings growth rate over the next several years, because natural forces, such as the law of large numbers and competition, will dilute growth.
I also think it’s very reasonable to assume NVDA stock gets a 30 multiple in 2021. Right now, NVDA stock is trading at 53 times fiscal 2018 earnings. This multiple will assuredly fall over the next several years. That is the definition of growing into your valuation.
Consequently, I think it’s very reasonable to say NVDA stock will hit $300 in 3 years. If you discount that back by 10% per year, you get to a present value of around $225.
All else equal, that is the level I’m looking at as the point when NVDA stock has overshot itself. Until then, I will remain long NVDA stock, because demand for the Nvidia growth story is just getting stronger.
As of this writing, Luke Lango was long NVDA.