Pick Nvidia Stock over Micron for Higher Risk and Higher Reward

Nvidia stock - Pick Nvidia Stock over Micron for Higher Risk and Higher Reward

Source: via Nvidia

The semiconductor sector has been one of the market’s hottest the past couple of years, and both Nvidia (NASDAQ:NVDA) and Micron (NASDAQ:MU) have benefited. Even with a recent pullback, Nvidia stock has gained a whopping 953% over the past three years. MU stock has “only” tripled over that period, but it trades about 5x higher than it did at May 2016 lows.

Clearly, sentiment toward the space has weakened a bit and both stocks have felt that impact as well. MU stock has pulled back 26% from late May highs.

In its fiscal Q2, Nvidia beat consensus revenue and profit expectations for the 12th straight quarter, and the stock still fell. Nvidia stock now has pulled back about 10% from its highs.

The declines lead to a number of interesting questions. Does the space as a whole have more downside ahead? If not – if this is just a minor sell-off ahead of more gains, which is the better play?

From here, there’s an intriguing case for both stocks, and the decision simply might come down to personal preference.

Semiconductors Changes and Nvidia Stock

Historically, the semiconductor space really hasn’t been that great a sector to invest in. Intel Corporation (NASDAQ:INTC) still trades well below dot-com bubble highs.

Until a recent run, INTC stock was basically flat to its highs even after the bubble popped. Texas Instruments (NASDAQ:TXN) has been a long-term winner, and investors who timed their trades right (or saw a buyout) could make money in the sector.

Still, semiconductor stocks tended to be reasonably cheap, for a number of reasons. Demand was cyclical, leading to lumpy earnings.

Moore’s Law meant chipmakers had to release ever-faster products; competition kept pricing power low. The iShares PHLX Semiconductor ETF (NASDAQ:SOXX), which tracks the Philadelphia Semiconductor Index, was basically dead money from the dot-com bust through 2013.

That ETF has nearly tripled over the past five years, however, as the sentiment toward the sector has changed notably. Major trends like autonomous driving, cloud computing, and the Internet of Things imply huge, long-term, consistent demand growth.

Obviously, both Micron and Nvidia stock have benefitted amid the rising optimism toward their sector. Nvidia’s datacenter sales are soaring, and its automotive business has great promise. Micron has benefited from a steep rise in memory prices.

Competition and Nvidia Stock

The interesting question for the space as a whole, however, is whether the sentiment has gone too far in the positive direction.

Demand trends do look better. The sector’s cyclical nature is being smoothed out but competition remains stiff.

Advanced Micro Devices (NASDAQ:AMD), for instance, is becoming a legitimate rival to Nvidia in GPUs. Intel is trying to defend its dominance in datacenter. Micron is relying on its rivals to keep supply in check – and avoid a dreaded plunge in memory prices.

The news surrounding chips unquestionably is better. But this still is a tough space – as shown by the valuation of MU stock.

The Case for MU Stock

MU stock looks like a value investor’s dream. The stock, seemingly incredibly, trades at barely 4x consensus EPS estimates for both FY18 and FY19.

There are reasons for the compressed multiple, as I wrote back in March. Memory prices are at a peak, and they are going to come down at some point. That in turn suggests that Micron earnings will fall as those gained and lost pricing dollars fall to the bottom line at huge margins.

So MU stock should be cheap at this point in the cycle. The question is whether it’s just too cheap, even accounting for those considerations. DRAM and NAND demand should stay reasonably solid. So far, rivals like Samsung and SK Hynix have kept capacity expansion to at least reasonable levels.

And, here, if an investor believes that the cyclical nature of the chip space has been smoothed out even somewhat, then the market appears to be overreacting. I think that’s likely the case.

The chart is ugly, and there’s a case for selling puts on MU stock as a hedged entry. Still, even if the market is right that Micron earnings are going to decline, a 4x multiple already is incorporating a huge cut. And that leaves MU looking like an attractive play for value investors.

The Case for Nvidia Stock

In contrast, Nvidia stock is not cheap, even after the pullback. NVDA still trades at 30x FY20 consensus EPS, a big multiple for the market, and a huge multiple in the chip space.

Of course, few companies – and basically no semiconductor companies of any size – are growing the way Nvidia is. Revenue in the second quarter jumped 40%.

Adjusted EPS nearly doubled (+92%). And Nvidia’s growth is sustainable. Gaming demand continues to rise worldwide. Nvidia’s market share in datacenter still is small relative to Intel, suggesting room for the combination of share gains and market growth. The automotive business remains in the early stages (just 5% of revenue).

And with the pullback, Nvidia looks like one of the more attractive growth stories in the market. 30x earnings isn’t cheap, and EPS growth is going to decelerate rather quickly. But, and this is particularly true if an investor believes the industry truly has changed, Nvidia stock probably shouldn’t be cheap.

This isn’t Micron, where cycles are going to turn on the company. The growth runway here is intact for years to come.

The case for Nvidia is that its upside probably is greater than that of Micron – which might seem counterintuitive given the massive gap in earnings multiples. But Nvidia is going to grow in a way that Micron probably can’t.

MU stock always is going to be some level of cheap; Nvidia can stay expensive for a long time to come. At these levels, I expect upside in both, with Nvidia stock the higher-risk, and higher-reward play.

As of this writing, Vince Martin has no positions in any securities mentioned.

Article printed from InvestorPlace Media, https://investorplace.com/2018/08/pick-nvidia-stock-over-micron/.

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