Why the Second Half Is So Crucial for Nvidia Stock

For Nvidia (NASDAQ:NVDA), 2019 has been much better than 2018. Nvidia stock closed last year having lost over 50% of its value in just three months. It’s recovered some of that decline this year: NVDA stock has risen 34% in 2019.

Nvidia Stock Soars After Fourth Quarter, So Now What?

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The strength of Nvidia stock is being driven by several factors. General optimism toward the semiconductor space has helped. The iShares PHLX Semiconductor ETF (NASDAQ:SOXX), based on the Philadelphia Semiconductor Index, is up 20% year-to-date. (The index, perhaps surprisingly, actually threatened its all-time highs earlier this month.) Tech on the whole is performing well, with the NASDAQ 100 (of which Nvidia is a component) gaining 16% YTD.

But the biggest driver of Nvidia stock seems to be an increasing belief among investors and analysts that NVDA is headed for a rebound in the second half of 2019. We know the first half is going to be difficult, as Nvidia deals with the aftereffects of what looks to have been a “crypto bubble” last year. With crypto demand now close to zero, NVDA has too much inventory and faces tough comparisons in fiscal Q1 and Q2.

Indeed, NVDA itself is guiding for a 30%+ decline in sales in the first quarter. For the full year, however, the company expects its revenue to be “flat to down slightly,” per its Q4 release. To meet its annul guidance, its revenue has to ramp quickly  and sharply, particularly in Q3 and Q4.

But the importance of the second half goes beyond NVDA’s guidance  and beyond its 2019 results. And so it’s not too early for investors to look ahead to the second half of the year and to understand both the potential rewards and the potential risks of Nvidia stock.

The Second Half And Nvidia Stock

From a broad standpoint, the bull case for NVDA stock is reasonably simple. Its growth in fiscal 2019 was boosted by the demand of crypto miners, and Nvidia paid the price for that growth in the first half of fiscal 2020. But the broad story – the one that led investors to pay nearly $300 for Nvidia stock last year – still holds.

Demand from the gaming sector for Nvidia’s products should continue to grow – and Nvidia should continue its dominance of that key market, even amid tougher competition from Advanced Micro Devices (NASDAQ:AMD). Similarly, NVDA’s datacenter sales have a multi-year runway for growth. Nvidia already is taking share from Intel (NASDAQ:INTC) in the latter area. Its acquisition of Mellanox (NASDAQ:MLNX) further strengthens its positioning in datacenter and high-performance computing.

But the positive outlook on Nvidia stock will only hold if  its second-half results are impressive. If Nvidia can show that it can still drive growth without crypto, the high multiple of Nvidia stock (at least by semiconductor stock standards) will hold, enabling  NVDA stock to keep soaring.

But if its second-half results disappoint, then the positive outlook of Nvidia stock will break down, since it will have been shown that Nvidia’s growth opportunity simply isn’t as large as investors had believed. And there are three key aspects of the outlook of Nvidia stock that could come under pressure when its results start to normalize in Q3.

The Risks Facing Nvidia Stock

NVDA remains heavily reliant on sales to the gaming sector, which drove 53% of its FY19 revenue, according to its 10-K. And so it’s interesting that, particularly of late, Nvidia stock is outperforming gaming stocks. Video-game software developers Activision Blizzard (NASDAQ:ATVI) and Take-Two Interactive (NASDAQ:TTWO) aren’t terribly far from their lows, after they suffered steep declines at the end of 2018.

It certainly seems like the overall growth of the gaming sector is slower than investors had believed. And with AMD becoming a stronger rival, the relative weakness of the gaming market creates a key risk to Nvidia stock.

If NVDA can’t increase its sales to gaming customers once it works through the crypto headwind, NVDA stock will have an enormous problem. A company can’t drive consolidated growth when half of its sales are relatively stagnant. And if Nvidia’s growth is likely to be limited in FY21 and beyond, Nvidia stock isn’t going to trade for 25 times its earnings.

The other category to watch closely is datacenter. Datacenter drove a quarter of NVDA’s revenue in FY19, and NVDA’s datacenter business grew over 50%. But here, too, Nvidia is dependent on a second-half rebound, as the spending of its datacenter customers has slowed dramatically. That is a market-wide problem: Intel, too, has been affected by the slowdown. But if  the datacenter sector doesn’t rebound in the second half, then the longer-term opportunity in the category looks far less attractive.

That, too, is a risk to Nvidia stock. For all the hype about Nvidia’s role in self-driving cars, the automotive sector drives barely 5% of its total sales. Gaming growth is going to decelerate going forward. Datacenter is a key piece of the company’s growth outlook at this point, and it needs to come back meaningfully in the second half to prove that the growth story will remain intact.

The Debate About Nvidia Stock Is Starting Now

For the next few months, bulls and bears on Nvidia stock are likely going to be in an argument over whether NVDA will rebound in the second half and just how strong that rebound can be. That’s not to say that its first-half results won’t matter at all, but the market’s attention will stay firmly fixed on the third and fourth quarters.

And there’s one more aspect of the outlook of NVDA stock that will be impacted by its second-half results. Nvidia’s management badly misread the crypto craze last year. Investors at the moment seem to be forgetting – or at least forgiving – that error. If Nvidia is proven to have over-promised again, the reaction may be different the second time around.

It’s worth noting that analysts, at least, are skeptical: consensus estimates project a nearly 5% decline in revenue this year, worse than the company’s guidance. And I’m surprised more investors don’t see Nvidia stock, after the last few quarters, as a “show me” story. At the moment, those investors instead seem willing to trust the company’s guidance and believe that a rebound is just a few months away. Given the current price of Nvidia stock, they’d better be right.

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

Article printed from InvestorPlace Media, https://investorplace.com/2019/03/second-half-crucial-nvda-stock-nvidia-stock/.

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