Growth at a Reasonable Price Fuels Nvidia Stock as Market Buys Turnaround

Nvidia (NASDAQ:NVDA) stock has moved up 16% since I highlighted in late August its turnaround potential. I argued that demand from artificial intelligence (AI) applications such as gaming and data centers would push earnings higher as well as NVDA stock.

Growth at a Reasonable Price Fuels Nvidia Stock as Market Buys Turnaround
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Seven weeks later, Nvidia’s financial outlook is still very positive. Analysts expect Nvidia will earn $5.34 for the year ending January 2020 and $7.13 for the January 2021 year, according to Seeking Alpha. More importantly, the majority of the earnings estimate revisions have been higher in the past 90 days.

This puts NVDA stock at a very reasonable 25.5 times earnings for the next fiscal year ending January 2021. Moreover, the balance sheet and cash flow statement are in good shape.

NVDA has $8.5 billion in cash, no debt and is free cash flow positive. Its latest Q2 filings showed that its free cash flow was $823 million for the quarter, and this represented 89% of its net income of $923 million.

I estimate that NVDA will have accumulated $10.7 billion in cash by the end of the year. NVDA has suspended its share buybacks until then. After its purchase of Mellanox Technologies (NASDAQ:MLNX) is completed at the end of the year, it will still have over $3.8 billion left over.

NVDA is now back on a growth path. Two months ago when I wrote up NVDA stock it was trading for $156.83 after hours. Today it is $181.97. The market is starting to believe in the turnaround.

The Stock According to GARP

Analysts call this type of stock a GARP stock (Growth-at-a-Reasonable-Price). It is not as cheap as a traditional value stock at less than 15x earnings. As a trade-off, NVDA offers a high growth rate in its underlying fundamentals.

The stock is not overpriced like a traditional momentum type stock. For example, ROKU (NASDAQ:ROKU) is very overvalued, as I wrote last week how the market is overvaluing its earnings growth. NVDA stock has a reasonable price in line with the level of fundamental company growth.

A well-read academic article in the Journal of Applied Business Research, “The Role of Growth in Long Term Investment Returns,” detailed a phenomenon about growth stocks. Those stocks that are highly valued in relation to fundamental values tend to underperform. This is despite the fact that a highly priced stock implies a high growth rate for the company.

This phenomenon has led to more traditionally growth or momentum investors turning to GARP investing instead. NVDA stock displays a lot of characteristics of GARP investing that these traders like.

AI Growth Story

AI is at the center of the Nvidia stock growth story. For example, Nvidia claims that AI will accelerate computing innovations, the Internet of Things (IoT), and transform the wireless industry.

A recent article in the Harvard Business Review, “Building the AI-Powered Organization,” underscores this point. The article argues that AI is powering data-driven decision making in firms. This affects everything in the organization from marketing to budgeting.

Nvidia expects to be in the center of this increasing focus on AI by corporations. Nvidia believes their chips will bring edge computing and storage closer to the point of action and decision making.

Bottom Line on Nvidia Stock

Nvidia’s business is now showing clear signs of a turnaround. This is because demand for its AI chips in gaming and data centers is rising. It is generating free cash flow each quarter and will be accumulating cash up to year-end when it buys Mellanox. At this price, Nvidia stock has a reasonable P/E ratio. It is still a good time to jump back in on Nvidia stock.

As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here. The Guide focuses on high total yield value stocks. Subscribers a two-week free trial.

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