Back in September 2018, Nvidia (NASDAQ:NVDA) seemed unstoppable, hitting an all-time high of $292 in the markets. But since then, Nvidia stock has been hit with a burst of volatility. As of now, NVDA is at $159. This represents a 45% plunge from the high.
So what went wrong here? Well, part of the problem was that expectations got out of hand. There was also the steep correction at the end of the year. And finally, Nvidia’s financial results started to go south in a big way.
Frankly, Thursday’s critical first-quarter of 2019 earnings report didn’t do much to alleviate concerns. Although Nvidia beat the print on profitability and revenue, the overall results failed to impress. For instance, top-line sales fell 31% year-over-year as analysts anticipated.
Thus, it all came down to guidance. Even here, management didn’t provide a comfortable read. Updated revenue expectations for $2.55 billion in Q2 dropped lower than prior estimates. The reason? Key market segments like data centers remain soft.
In other words, uncertainty reigned before Q1, and it still does following the earnings disclosure. So to get a better view, let’s take a look at the pros and cons for NVDA stock:
Secular Trends: Artificial intelligence (AI) and cloud computing are two of the most important megatrends in technology. They have been key drivers for companies like Microsoft (NASDAQ:MSFT), Amazon.com (NASDAQ:AMZN), Alphabet (NASDAQ:GOOGL, NASDAQ:GOOG) and Facebook (NASDAQ:FB).
The good news for NVDA stock is that its graphics processing units (GPUs) have proven to be ideal for AI and cloud computing. This semiconductor technology is able to process huge amounts of data cost-effectively. Essentially, Nvidia’s GPUs have become the standard in the industry.
True, there is competition emerging, such as from Advanced Micro Devices (NASDAQ:AMD). Even companies like AMZN and FB are creating their own chip technologies. Let’s face it, customers want alternatives.
But the fact remains that the market opportunity for AI and cloud computing is enormous, allowing for multiple winners. According to the latest NVDA investor presentation, the estimated size for the data center is $50 billion, while the market for AI and self-driving cars is $30 billion.
Dealmaking: Earlier in the year, NVDA agreed to shell out nearly $7 billion for Mellanox Technologies (NASDAQ:MLNX). While the valuation was rich – there were several bidders for the deal such as Xilinx (NASDAQ:XLNX) and MSFT –it should be worth it.
First of all, NVDA and MLNX have worked together for quite some time. But more importantly, MLNX will add more depth to the product line, like offerings for internet connections for high-speed computers.
All this is about getting a larger share of the data-center market. And to succeed, there will need to be integrated solutions that can perform at hyperscale, which will allow for next-generation technologies like self-driving vehicles and quantum computers.
Valuation: No doubt, NVDA is much cheaper now! Consider that the forward price-earnings (P/E) multiple is about 23x or so. From a historical standpoint, this is on the low end. For a company that has dominant positions in AI, gaming and the data center, the multiple does look fairly reasonable.
Another point is that analysts have been getting more bullish on NVDA stock as well. For example, Jefferies has raised its price target from $185 to $227. Also, UBS has increased its own target from $180 to $210.
Growth: The main drivers for Nvidia — gaming and the data center — have been sputtering. It also does not help that Intel (NASDAQ:INTC) recently reported disappointing results, with data center as the main culprit. It’s far from clear what is going on. If anything, the softness does seem anomalous since cloud computing appears to be in growth mode.
Yet there have been global economic pressures, such as in China and Europe. The trade tensions may have also led to higher spending on chips in earlier quarters to bolster inventories to ward off potential supply-chain disruptions.
The big question: is this temporary or could it be prolonged? It’s tough to tell. Management’s comments during the conference call echoed rivals in the sector. That is, it’s anybody’s guess how the tensions play out.
The Paradox of Innovation: Sometimes it is good not to be too pioneering with technology. The market may not be ready for it. Interestingly enough, this may have been the case with the RTX gaming chip. While it is cutting-edge, there has been little adoption so far. Unfortunately, this has been another drag on the financial results.
What’s more, the investments in self-driving technologies may take much longer than expected. This type of innovation is exceedingly complex and also requires changes in regulations, customer behavior and even city infrastructures.
U.S.-China Trade War: This is perhaps the biggest risk factor for Nvidia stock. About 23% of the company’s revenues come from China. There is also much exposure from the supply chain in Asia.
But the impact of the U.S.-China trade war could go well beyond tariffs. RBC analyst Mitch Steves indicated that government actions from the U.S. could mean that Nvidia will be prohibited from selling to China because NVDA-derived technologies are strategic. If so, this would definitely be devastating for Nvidia stock.
For those with a long-term focus, I think the pros outweigh the cons on Nvidia stock. The company is nicely positioned to benefit from powerful trends like cloud computing and AI. There are also emerging categories like the Internet of Things and robotics. And yes, the MLNX acquisition should be a nice driver.
Yet investing amid the aftermath of Nvidia earnings looks dicey, especially considering the bearishness in the markets and the uncertainties with U.S.-China relations. So it’s probably best to avoid making a purchase right now and let the dust from Q1 settle.
Tom Taulli is the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.