Shares of Nvidia (NASDAQ:NVDA) have been ripping higher lately. NVDA stock is up nearly 10% over the past four trading days alone, outpacing even the torrid gains for the semiconductor stocks in that same time frame. While certainly some of the rally was warranted given a decent earnings beat, Nvidia stock has now come too far, too fast. Look for a pullback in NVDA over the coming weeks.
Nvidia reported earnings on Aug. 15 with earnings per share of $1.24 beating estimates for $1.15. Revenues, however, were less impressive, coming in roughly in line at $2.58 billion. The revenue numbers actually represented a 17.3% year-over-year decline. Yet NVDA stock still moved up big following the report, adding on over 20%. An 8% earnings beat with flat revenue means that most of the move was obviously due to a big multiple expansion.
InvestorPlace contributor Chris Lau noted yesterday that the average analyst price target was $189.96 — implying less than 5% upside from current levels. That doesn’t look too rewarding to me.
Nvidia stock is certainly getting more expensive from a fundamental view. The trailing price-to-earnings ratio now sits above 40 and at a premium to the five-year average of 34. It has risen sharply even factoring in that most recent earnings beat. Price-to-sales is just over 10, far exceeding the five-year average of just 7.5 and nearing the highest levels ever. Other valuation metrics, such as price-to-book and dividend yield, are similarly rich. NVDA is most assuredly not a cheap stock at current levels.
Nvidia Stock Charts
NVDA stock is getting overbought on a technical basis. The five-day relative strength index just breached the 75 level which has marked short-term tops in the past. The moving average convergence/divergence is also fast approaching readings that signaled the rally may be getting overdone. Bollinger Percent B broke above 1 before weakening, yet another sign of too much exuberance. Nvidia stock is trading at a large premium to the 20-day moving average. This has usually been a prelude to a pullback.
More importantly, NVDA failed to break past major resistance at $184 yesterday. Nvidia stock traded up to a high of $183.98 only to subsequently reverse course and close well off the highs. This type of intra-day reversal pattern is often indicative of a significant top. The buyers have finally become exhausted and the sellers are in control. It is especially powerful near major resistance and following a strong rally like just evidenced in NVDA stock.
The Bottom Line on NVDA Stock
I previously had a bullish outlook on NVDA with shares trading at the $155 area. Now that Nvidia has rallied sharply, my viewpoint has changed as well — because price does matter. The current P/E ratio expanded by 33% since late May, moving from 30 to 40. The oversold technicals back then have now flipped to overbought. It’s time to take a more bearish stance on NVDA stock.
Investors should use any further strength in the Nvidia stock price to take a short position. The initial downside price target would be the 20-day moving average at the $165 area. A significant break above resistance at $184 would be a logical stop out level.
Implied volatility is only at the 16th percentile, meaning option prices are comparatively cheap. This favors option buying strategies when constructing trades. Option traders may elect to take a guardedly bearish position by purchasing a bear put spread.
Buying the NVDA Oct $180 puts and selling the NVDA Oct $175 puts could be done for a $2.00 net debit. Maximum risk is $200 per spread with a maximum gain of $300 per spread if NVDA stock closes below $175 at expiration on Oct. 18. Potential return on risk equates to 150%.
Tim may hold some of the aforementioned securities in one or more of his newsletters. Anyone interested in finding out more about Tim and his option-based strategies can go to https://marketfy.com/item/options-and-volatility.