Shares of Nvidia (NASDAQ:NVDA) look to have finally found some pushback after a major post earnings rally. NVDA stock has risen over 16% (45 points) since reporting on Feb. 13.
Certainly some of the rip higher was warranted given that both the EPS and revenues topped expectations handily.
The rally, however, has now come too far, too fast. Look for Nvidia to struggle over the coming weeks.
Valuation View
The earnings report was a big beat on both the top and bottom line. EPS checked in at $1.54 per share on a GAAP basis. This trounced consensus for just $1.34 in earnings. Revenues were also a beat, albeit a smaller one. Sales came in at $3.11 billion, 5% higher than analysts expectations. The company did lower revenue estimates for the coming quarter due to the coronavirus fears. Our own William White did a superb in-depth drill down on earnings last week.
Click to EnlargeBulls point to the fact that revenues gained 41% YOY. This is true, but the stock price has more than doubled in that same time frame. A 40% increase in sales with the stock rising 100% means that the price/sales ratio has expanded by an astronomical 150%.
This puts current P/S ratio at nearly 18x — twice the 5-year average of a rather rich 9 times sales. The 18 multiple is at by far the loftiest level in the past decade. Other valuation metrics, such a P/E and Price/Book, are at similar extremes.
Technical Take
The techicals are similarly stretched to extremes just like the fundamentals. 14-day RSI printed above 80 and reached the highest readings of the past two years before finally weakening. MACD checked in at a two-year high as well. Momentum unbelievably hit 70 before it, too, softened. Bollinger Percent B echoed the over-exuberance with a reading above one before turning lower.
NVDA stock is trading at a huge premium to both the uptrend line and 100-day moving average at the $247 area. Nvidia stock isn’t just overbought — it is historically overbought.
Click to Enlarge
Most importantly, NVDA stock had a big time reversal day yesterday. Shares briefly traded up to new highs at $316.32 before ultimately changing course to close sharply lower on the day at $308.70. This type of price action is many times emblematic of a top in the stock.
The buyers have become exhausted and the sellers are now in control. It is an even more powerful indicator given the magnitude of the previous rally in NVDA stock. The upside momentum looks to finally be broken.
Probabilities look to favor a pullback given that valuations and technicals are now both at extremes. I am not disputing that Nvidia is growing, but instead questioning how much one should pay for that growth. Momentum can only take a stock so far before valuations begin to matter.
Trading NVDA Stock
Stock traders should look to short Nvidia stock on any strength. The initial profit objective would be a move back towards the post-earnings gap at $285. A meaningful break out to fresh new all-time highs is a viable stop out area.
Option traders can take advantage of still somewhat elevated implied volatility and sell an out-of-the money bear call spread. The March $335/$340 call spread should bring in about 80 cents in net premium. Maximum gain the trade is $80 per spread with maximum risk of $420 per spread. Return on risk is 19%. The short $335 strike price provides a 8.5% upside cushion to the $308.70 closing price of NVDA stock. It is also structured well above the all-time highs in Nvidia.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at timbiggam@gmail.com.
