One of the reasons for caution toward Nvidia Corporation (NASDAQ:NVDA) over the years has been precisely that it’s a semiconductor stock. As stretched as the NVDA stock price might look — and it still trades at over 40x next year’s EPS, even backing out its cash hoard — it appears even more so in the context of its industry.
After all, semiconductor stocks generally trade at a discount to the overall market. And with good reason. Chip performance improves over time at a rate far faster than pricing increases. Cyclicality means growth may not necessarily be sustainable over a multi-year period. Micron Technology, Inc. (NASDAQ:MU) is a perfect example. Competition is intense, which often requires significant amounts of capital to expand and upgrade manufacturing capacity.
Most semiconductor stocks historically have traded with forward P/E multiples in the teens — and toward the beginning part of this decade, even lower. And so Nvidia’s premium valuation seems like an outlier. There have been high-multiple semiconductor stocks out there: Intel Corporation (NASDAQ:INTC) paid 31x revenue for Mobileye, with the goal of competing with Nvidia in automotive.
But from a “feel” standpoint, a chip stock of Nvidia’s size ($110 billion market cap) at 40x+ earnings simply seems incongruous. And investors who paid premium multiples for stocks like Intel or Advanced Micro Devices, Inc. (NASDAQ:AMD) last decade often saw their investments stagnate for years — at best.
So to justify its valuation, Nvidia has to not be just another semiconductor stock. The good news is that it likely isn’t — and certainly not yet.
Major Growth for NVDA Stock Price
At some point, Nvidia will be another chip stock. Intel in 1995 or so is an interesting parallel. As investors realized the coming PC boom, and the chipmaker’s role in it, INTC stock soared from below $5 to $75 at the peak of the dot-com craze. The company enjoyed years of growth in that market, before moving into data center and other applications in a bid to diversify away from slowing sales.
Intel might be seen as a cautionary tale for NVDA, which has made a similar run. The NVDA stock price has risen 1,470 percent over the past five years — about the same as Intel’s 1995-2001 trend. Yet INTC stock, to this day, still trades nearly 40% below those 2001 peaks.
There’s a key difference here, however. Nvidia has more markets — and they may be better markets. The core gaming business has years of growth in front of it, as high-end chips improve the experience and more gamers join from developing markets. That market will mature eventually, and Moore’s Law at some point will allow lower-priced competition to enter. But Nvidia still has years of growth ahead.
Meanwhile, both data center and automotive likely have even longer growth runways. “Cloud” growth might be a buzzword, but it’s only just beginning. And autonomous driving likely will be a multi-decade trend.
Those growth drivers mean that Nvidia just isn’t going to see the cyclicality present in results from many chip companies. And they in part explain why NVDA doesn’t deserve the same multiple.
Fabless Model Helps NVDA
Nvidia also benefits from its “fabless” model. Nvidia isn’t building the chips in-house. Rather it outsources production to suppliers like Taiwan Semiconductor Mfg. Co. Ltd. (ADR) (NYSE:TSM), Samsung, and memory producer SK Hynix.
As a result, Nvidia doesn’t require the capital spend of an Intel or a Micron. That limits major one-time expenditures for building out new fabs or upgrading capacity. In the long run, it means its free cash flow actually is better than its earnings might suggest, as capital expenditures are lower than depreciation and amortization.
That model also de-risks Nvidia’s business model somewhat. Should demand stumble — say, if a recession leads to a pullback on gaming spend — Nvidia simply can back off orders, and limit the downside pressure on margins. That’s not to say Nvidia’s model is bulletproof, or that it won’t see some pressure if sales decline, or even if growth slows. But the huge swings at Micron — which went from losing money five years ago to earning $5.6 billion in its most fiscal year on an adjusted basis — won’t be seen here.
Bottom Line on NVDA Stock Price
Admittedly, I’ve gone back and forth on Nvidia stock this year, and I’m still not 100% convinced from a valuation standpoint. The growth potential here, across the board, is outstanding. But a lot of that growth already looks priced in.
Still, I see enough reason to stay bullish on NVDA, if moderately so. And at the least, I see no reason to expect Nvidia to come back toward its peers. Chip stocks generally are treated very differently than NVDA is. But that’s precisely what makes the stock so intriguing.
As of this writing, Vince Martin has no positions in any securities mentioned.