Shares of graphics processing unit (GPU) maker Nvidia (NASDAQ:NVDA) have been on fire recently, rising 80% over the past six months to fresh 52-week highs on the back of rebounding demand in the global semiconductor market. Most recently, the GPU maker reported robust fourth-quarter numbers which easily breezed past revenue and profit expectations — and even included a better-than-expected guide.
What’s lighting the fire? Big cloud data center providers are accelerating their spending on Nvidia’s GPUs as U.S.-China trade tensions continue to ease.
That’s the good news. The bad news, though, is that Nvidia stock is closing in on a big technical resistance level: the $300 mark.
While Nvidia stock looks unstoppable right now, it also looked unstoppable back in 2018. Back then, shares essentially doubled over a 12-month stretch. Then, the stock hit $300. The rally stopped. Shares plunged.
Will the same thing happen this time around? Will the big rally in NVDA stock again be stopped at the $300 mark?
I don’t think so. But, I do think that caution is warranted at these levels. Yes, Nvidia is a great company getting its momentum back. That momentum should persist, and continue to drive shares higher. At the same time, though, the valuation is extended, and any misstep here could cause serious pain in shares, much like it did in late 2018.
Nvidia Is Back
If the fourth-quarter earnings report did anything, it clearly emphasized that Nvidia is back.
From 2015 to mid-2018, Nvidia was firing on all cylinders as the GPU backbone of several next-generation industries, like data centers, self-driving cars, artificial intelligence and automation. Revenues were rising rapidly. Gross margins were expanding rapidly. Profits were soaring. So was the stock.
Then, in mid-2018, demand for Nvidia’s GPUs slowed dramatically amid escalating global economic uncertainty. Specifically, the U.S. Federal Reserve hiked interest rates all year long in 2018 and shrunk their balance sheet, while the U.S. and China went tit-for-tat in an escalating trade war. Those factors injected a ton of uncertainty into the global economic landscape, and all that uncertainty killed demand in the semiconductor market.
Nvidia’s revenues dropped. Gross margins compressed. Profits were wiped out.
In 2020, though, things are very different, and in a good way. The Fed cut rates all year long in 2019. They expanded their balance sheet, too, and have provided more fiscal stimulus over the past four quarters than they have in years. Central banks across the globe have similarly eased monetary policy. Simultaneously, U.S.-China trade tensions are easing, and project to keep easing into the 2020 U.S. presidential election.
All of these favorable developments mean that certainty is being re-injected back into the global economy. As certainty has come back, so has semiconductor demand. And now, Nvidia’s revenues, margins, profits and stock price are all rising again.
Nvidia Is Richly Valued
The bull thesis on Nvidia stock for 2020 is pretty simple and compelling.
The global economy is improving. Semiconductor demand is rebounding. Nvidia’s revenues, margins and profits are moving higher. All of this will continue for the next few quarters because: 1) President Donald Trump doesn’t want to upset trade relations in an election year, 2) China can’t afford to upset trade relations while dealing with fallout from the coronavirus and 3) central banks across the globe remain committed to easy money policy and low rates.
Thus, the global economy will keep improving in 2020, semiconductor demand will keep rebounding and Nvidia’s revenues and profits will keep marching higher.
Naturally, that means Nvidia stock should march higher, too, right? Yes. But, there’s a catch.
The valuation here is very rich. At 31.5 times forward earnings, the stock is trading near an all-time high. Bulls will argue that the premium valuation is warranted by robust long-term profit growth prospects. That’s somewhat true, but there are flaws in that argument. Even if you model out the company’s realistic long-term growth prospects (sustained double-digit revenue growth, continued margin expansion and buybacks), the valuation today still doesn’t add up to a $300 price tag.
Bottom Line on NVDA Stock
Nvidia is a great company and this stock is a solid growth stock to own for the long haul. But, I wouldn’t chase this rally. Shares may grind higher thanks to operational momentum. Nvidia’s valuation is also a concern.
Ultimately, the semiconductor industry and this company are so volatile that investors will probably get a better opportunity to buy the stock lower at some point over the next few months.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
