Shares of chip stock Nvidia (NASDAQ:NVDA) have been on a roller coaster ride over the past year. Once an unstoppable growth stock that powered from $30 to $300 in less than three years, Nvidia stock tumbled in late 2018 to $120 on slowing growth, rising inventory, and compressing margins.
Nvidia stock has since clawed its way back to $175, and the market is unsure about where NVDA will go next. Bulls are saying this is the beginning of a multi-year turnaround, powered by the cloud, artificial intelligence (AI), and the Internet of Things (IoT). Bears say Nvidia stock should be sold because trade war and competition risks are very real and not going away anytime soon.
Which thesis is right? In short, both have merit. In the long-run, optimism is warranted towards Nvidia stock because the non-cyclical growth drivers are in place to power robust revenue and profit growth over the next several years. But caution is warranted towards Nvidia stock in the near-term. That’s because optical and fundamental risks do add uncertainty as to when exactly the company will resume growing.
As a result, I think it’s best to be cautiously optimistic about Nvidia stock now. Be cautious when buying NVDA stock in the near-term because it will likely remain choppy. But be optimistic about its long-term outlook because the shares will power higher in the long-term.
Cautious Is Warranted on Nvidia Stock
In the near-term, investors should be cautious about Nvidia stock.
Taking a step back, Nvidia was growing rapidly from fiscal 2014 to fiscal 2019, a stretch during which NVDA jumped head first into the cloud, AI, and IoT markets. During that period, it had 20%-plus revenue growth each year, rapidly expanding margins, and greatly increasing profits.
Its rapid growth stopped in late fiscal 2019. Global chip demand slowed amid escalating trade tensions between the U.S. and China. That slowdown happened as Nvidia’s inventory levels hit record levels. Thus, not only did Nvidia’s revenues get hit, but its margins got hit, too, because the company had to clear its inventory during a period of slow demand.
As a result, in fiscal 2020, its revenues, margins, and profits have all dropped sharply.
It’s uncertain when these three metrics will rebound. There has been some positive talk on the trade-war front But a trade resolution is unlikely in the foreseeable future for a few reasons. First, U.S. President Donald Trump is dealing with an impeachment inquiry. Second, China has no incentive to strike a deal when its “adversary” is essentially on trial. Third, the U.S. has an election coming up in 2020, and China has no incentive to strike a deal before then, either.
Thus, while the trade war may not get much worse in the intermediate term, there probably won’t be a resolution to it soon. Without a trade deal, Nvidia stock will have a tough time bouncing back tremendously.
Long-Term Optimism Is Warranted
In the long-term, the outlook of Nvidia stock is bullish.
It’s important to remember that the semiconductor market is cyclical. It has grown at a 5% compound annual growth since 2000, according to the Semiconductor Industry Association. But it is also prone to dips every few years. As a result, the decline of global semi sales isn’t all that unexpected or surprising; instead, it’s par for the course.
A rebound from this dip is also par for the course. All other slowdowns in the global semi industry over the past twenty years have lasted between 12 and 16 months, and were followed by renewed growth. We are currently ten months into this slowdown, which started in December 2018. Thus, history indicates that the semiconductor market should rebound in 2020.
Importantly, Nvidia’s share of the global semi market has climbed from 1.5% in calendar 2015 to 2.5% in calendar 2018, mostly thanks to the company’s products becoming the graphics backbone of multiple non-cyclical growth industries, like cloud, IoT, and AI. All of those markets look poised to continue growing rapidly over the next few years.
In other words, all the growth drivers are in place for Nvidia’s share of the semiconductor market to keep rising in the long-run. This steady share expansion should power double-digit percentage revenue growth for the next several years, That should be accompanied by margin expansion as the company sells more of its higher-margin products.
Beginning in 2020, Nvidia’s profits should increase 15% or more. Nvidia stock presently trades at 30 times its forward earnings. That combination should make NVDA stock work in the long-run.
The Bottom Line on NVDA Stock
Nvidia stock has been on a roller coaster ride over the past several months. But its core fundamentals haven’t changed. Nvidia is the graphics backbone of all of tomorrow’s most important industries. As a result, in the long run, Nvidia should grow rapidly.
Sure, in the near-term, its growth has been impacted by the trade war. But such slowdowns are par for the course in the semi industry. The trade war won’t persist for many years. Consequently, while near-term caution is warranted towards NVDA stock, so is long-term optimism.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
