Nvidia (NASDAQ:NVDA) has been stuck in a trading range between $160 – $180 since July. Although Nvidia stock could easily break-out as its growth potential returns, China tariffs may pressure chip stocks in the weeks ahead.
The investor who chooses to buy Nvidia stock, betting that the trade war tensions will end, risks macro headwinds. And those who wait it out may miss out on a rally if Nvidia reports strong quarterly results in November. What should investors do?
Look Beyond Short-Term
Nvidia is perfectly positioned to embrace the long-term growth in AI, IoT, and autonomous capabilities. CEO Jen-Hsun describes AI as being thousands of different types of networks. These networks get more complex over time, and the data that gets processed gets bigger. As a result, AI software cannot predict what is going to get programmed. Nvidia’s CUDA architecture is programmable, with its Tensor Cores are optimized for AI.
Software capabilities that combine IoT with AI will be the next phase of growth. Nvidia is well-positioned to lead the market when this phase begins. Within many sectors, automation is the future and is something that will happen.
This transformation is still in the early phases, so the company will not realize its potential until later. To position itself for these markets, Nvidia is investing heavily in itself. In its second quarter, the company reported GAAP operating expenses of $970 million. It is on-track to grow operating expenses in the high single digits.
NVDA singled out AI, graphics, and self-driving cars are the key platforms that will drive its long-term growth. Despite GAAP EPS falling 49% to $0.90, Nvidia is clear on its Q3 outlook. It forecast revenue of $2.9 billion and GAAP and non-GAAP gross margins at 62% and 62.5%, respectively. Capital expenditures will be in the range of $100 million to $120 million.
Nvidia’s Outlook for Gaming
Seasonal strength for Nintendo Switch will result in a production ramp-up in Q2 and in Q3, then likely falling in Q4. RTX (real-time tracing) is a differentiating solution to GPUs made by Advanced Micro Devices (NASDAQ:AMD). In the last few months, Nvidia announced six blockbuster games that adopted RTX.
There are now over 40 ISV tools that announced ray tracing and video editing, in the creative tools software space. Some of the applications have AI capabilities that fully utilize RTX.
Looking ahead, NVDA stock may potentially price in the pickup in demand for RTX-powered GPUS and notebooks offering this technology. Nvidia also benefits from the trend of gamers demanding light notebooks that have powerful graphics. Its customers need such systems for 3D content creation and high-definition video editing and image optimization.
The company introduced a new line of computers, called RTX Studio, that appears to such power users. Considering that the SUPER line of GPUs will spur sales in the quarters ahead and chances are good that the stock etches higher.
Trade War Risks and Nvidia Stock
Chip stocks are vulnerable to the tariff showdown between the U.S. and China. Such taxes hurt trade and weaken demand for semiconductor products. Nvidia is not immune to the impact escalating trade wars will have on trade.
The lack of a trade deal between the two countries may threaten the Nvidia-Mellanox (NASDAQ:MLNX) merger. In March, Nvidia offered $6.9 billion, or $125 a share, for Mellanox and paid entirely in cash. MLNX stock topped $120 by May but fell to $107 recently. Markets are signaling a higher probability that the deal will fall through.
Investors who held Qualcomm (NASDAQ:QCOM) and NXP Semiconductors (NASDAQ:NXPI) after the former offered to buy the latter did poorly holding NXPI stock. China’s regulators failed to approve the deal in a timely fashion, forcing Qualcomm to abandon the deal.
Valuation and Your Takeaway
Wall Street analysts are bullish on Nvidia stock and have an average $189.96 price target. Investors who prefer to build their own model may assign a ~7% revenue 5-year CAGR. In a DCF EBITDA Exit model that assumes revenue growth of up to 20%, the fair value is $186:
|(USD in millions)||Input Projections|
|Fiscal Years Ending||19-Jan||20-Jan||21-Jan||22-Jan||23-Jan||24-Jan|
|% of Revenue||34.70%||28.40%||32.90%||36.60%||37.60%||37.60%|
Still, investors may look at Nvidia’s intrinsic value based on future cash flow. In this scenario, NVDA stock has a significant downside (per simplywall.st).
Investors willing to hold Nvidia for a few years should accumulate the stock if it falls. The trade war is a short-term headwind that will eventually get resolved as both countries negotiate.
Disclosure: The author holds NXPI stock.