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Why Nvidia Stock Warrants Cautious Optimism Heading Forward

Nvidia stock finds itself stuck in a tug-of-war between improving fundamentals and a stretched valuation

Shares of graphics processing unit (GPU) giant Nvidia (NASDAQ:NVDA) have been on a wild roller coaster ride over the past 15 months, as shares have swung violently from $300 to $130, back to $200, amid a turbulent global semiconductor market backdrop.

Nvidia Stock Warrants Cautious Optimism Heading Forward
Source: Allmy / Shutterstock.com

The good news?

That turbulent global semiconductor backdrop will become increasingly less turbulent in 2020. The market will find its footing. Steady growth will come back into the picture. Nvidia’s revenue, margin and profit trends will meaningfully improve.

The bad news?

Nvidia stock may already be fully priced for all these improvements. That is, at nearly 40-times forward earnings, Nvidia stock is trading at near record-high valuation levels. Further multiple expansion will be hard to come by. Indeed, it is far more likely that shares get hit by multiple compression going forward.

In other words, momentum and valuation are caught in a tug-of-war with NVDA stock.

In 2020, I think that momentum will win that tug-of-war, and that shares will grind higher behind renewed profit growth and investor optimism. But, investors should proceed with caution, as valuation risks can rear their ugly head here at any time.

Nvidia’s Fundamentals Are Improving

The good news about Nvidia stock is that the fundamentals underlying the stock are dramatically improving, and will continue to improve into 2020.

The big idea here is simple. Global corporate confidence has been hit hard by escalating trade tensions since early 2018. As confidence has dipped, so has capital spending. The global semiconductor industry is built on the back of capital spending. Thus, as global capital spending has dipped, the global semiconductor market has dipped with it.

Now, those U.S.-China trade tensions are easing. They will continue to ease going forward, since both sides appear eager to reach a resolution amid what has been ugly economic fallout in both China and the U.S. As they continue to ease, corporate confidence levels will rebound. Rebounding confidence will spark a rebound in capital spending levels. A bunch of that capital spending will find its way into the semiconductor market. Thus, the semiconductor market appears positioned for a big rebound in 2020.

Further advancing this rebound will be: 1) a huge commercial 5G push in 2020, 2) the introduction of cloud gaming and new hardware gaming consoles and 3) resumption of data-center expansion spend from the cloud infrastructure giants.

Putting all of this together, it appears that Nvidia is well positioned to get back to growing at a robust rate in 2020. Revenue growth rates should surge higher. Gross margins should bounce back. Positive operating leverage will come back into the picture. Profits will soar higher.

Against this favorable rebounding growth backdrop, it’s easy to see Nvidia stock moving higher.

Nvidia Stock Is Richly Valued

Although it’s easy to see NVDA moving higher in 2020, it’s also easy to see shares being stuck in neutral once you look at the numbers.

Thanks to growth drivers in data, artificial intelligence and gaming, Nvidia is well positioned to sustain double-digit revenue growth in the long run. Gross margins should run higher thanks to ever-increasing demand and favorable pricing power. Opex rates should move lower, assuming ~10% expense growth against a 10%-plus revenue growth backdrop. Profits should run higher at a ~20% rate.

That’s a strong long-term profit growth rate. But, Nvidia stock trades at nearly 40-times forward earnings. That’s a 100% premium to its long-term 20% profit growth rate. For comparison purposes, the semiconductor sector’s forward earnings multiple is 30% above its long-term earnings growth rate.

Indeed, my math pegs the fair value of Nvidia stock at roughly $200 in fiscal 2020.

In other words, while the fundamentals are improving for Nvidia stock, the valuation has arguably already priced in all of these improvements.

Bottom Line on NVDA Stock

Going forward, Nvidia stock will be characterized by a tug-of-war between improving fundamentals and a stretched valuation. I’ve seen this tug-of-war many times before. Most times, the improving fundamentals side wins so long as the fundamentals do keep improving.

Nvidia stock won’t be an exception to this trend. Thus, while valuation friction may limit upside going forward, shares should trend higher in 2020, powered by improving semiconductor market fundamentals.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2019/12/nvidia-stock-cautious-optimism-heading-forward/.

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