Up 81% in 2019, going long Nvidia (NASDAQ:NVDA) was one of the year’s best plays. But as we enter 2020, does Nvidia stock have runway?
Valuation was frothy when shares traded between $175/share and $200/share. Now that the stock is at around $236/share, shares look even more overvalued.
Even with earnings projected to grow from $5.56/share in the current fiscal year (ending January) to $7.21/share in FY21, buying at 32.9 times forward earnings is a pretty price to pay for the privilege. Yet, NVDA bulls have proved me wrong before. Taking a look at my past analysis, I have argued “upside is priced in” like a broken record.
Nvidia is a “story stock“. That is to say, investor expectations, not valuation metrics, drive the Nvidia stock price. But will the music stop in 2020? It’s tough to call a top in this runaway market.
Outside of market enthusiasm, NVDA stock could move higher, thanks to growth potential in new markets. With this in mind, let’s see what’s the verdict for Nvidia shares going into 2020.
Nvidia Stock Catalysts
Several factors drove NVDA stock higher in 2019. Firstly, Nvidia moved beyond prior-year headwinds. As InvestorPlace’s Vince Martin wrote recently, Nvidia has stabilized sales declines caused by the cryptocurrency crash.
During the crypto bubble, demand for GPUs skyrocketed as crypto miners increased demand. But after the “crypto hangover“, GPU makers were left holding the bag. Nvidia lost big, as did its rival Advanced Micro Devices (NASDAQ:AMD).
Year-over-year, sales at Nvidia remain down. For the prior fiscal year, Nvidia generated $11.7 billion in revenue. But for the trailing twelve months, sales fell about 14.3%, to around $10 billion. But for FY21, analyst consensus calls for $12.8 billion in revenue.
Secondly, easing trade war concerns have benefited the markets, including NVDA stock. With this risk minimized, investors have justification to drive shares higher. The third factor driving Nvidia stock is future catalysts. Gaming may be Nvidia’s key market today. But long-term, it’s all about whether the company will reach new frontiers in data center, artificial intelligence (AI), and automotive applications.
AI and automotive may be years away. But Nvidia’s data center catalyst could help in the short-term. Piper Jaffray’s Harsh Kumar recently raised his price target on Nvidia stock from $230 to $250/share. A key reason? The company’s growth potential in the data center segment. Kumar is also bullish on the company’s prospects in conversational AI.
Nvidia’s valuation remains frothy, but there’s good reason why investors remain bullish. Many factors are working in favor of NVDA stock. Conversely, factors in play could push shares lower in 2020. Competition’s heating up in the chip space. With earnings growth priced in, investors could be disappointed if results do not meet expectations.
NVDA Stock Could Stumble
With shares just off their 52-week high, it’s easy to call a top in Nvidia stock. Yet, as we discussed above, there’s plenty of ammo for NVDA bulls to bid shares higher. On the other hand, Nvidia is “priced for perfection”. If the company fails to meet investor expectations next year, shares could see a correction.
How could Nvidia stock stumble in 2020? Competition is a big factor. For the past year, Nvidia has been fighting off AMD’s market share gains in GPUs. At one point, AMD’s success pushed Nvidia’s share below 70%. But thanks to the success of the company’s RTX line, they have regained much of the market share lost to AMD.
However, AMD’s GPU market share is still up year-over-year. Competing on both price and performance, AMD could continue to get the better of Nvidia. Meanwhile, Nvidia faces competition as it enters the AI space. Intel’s (NASDAQ:INTC) recent purchase of Habana labs could signal Intel isn’t sleeping on AI. Intel is also re-entering the GPU market in 2020 with its Xe line.
With these competitive pressures, the valuation Nvidia stock looks rich. NVDA’s forward price-to-earnings (forward P/E) ratio of 32.9 is less than AMD’s forward P/E of 42. But both major GPU names trade at much higher valuations than broad line chip maker Intel (forward P/E of 13.5). Granted, Intel doesn’t have the growth of its high-flier peers. But Intel’s big moves into Nvidia and AMD’s turf could disrupt their sales and earnings growth in 2020.
Stay on the Sidelines
My verdict on NVDA stock? Stay on the sidelines. I continue to believe Nvidia stock is overvalued. The company does deserve a growth premium to dinosaur Intel. But the current valuation is frothy, even when accounting for growth.
However, now is not the time to go short Nvidia stock. Investor sentiment is still on its side. Shares could rally higher, proving my “frothy valuation” thesis wrong again. It’s tough to see how NVDA could trade at a higher multiple. But its less clear when or if investor sentiment will turn bearish in 2020.
As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.
