On Tuesday, Nvidia (NASDAQ:NVDA) stock rocketed higher. Shares gained 17%, outpacing major indices on a day when the Dow Jones Industrial Average posted its best showing since 1933.
Nvidia bulls no doubt see more upside ahead. At Tuesday’s close near $249, shares still are down 21% from February highs. Long-term growth drivers remain in place once short-term disruption ends.
I’m sympathetic to that case. I became more constructive on NVDA stock last year ahead of the second-half recovery in the key data center market. Nvidia is one of the best companies in the semiconductor industry, and perhaps all of tech. There’s a strong argument that investors should focus on the long term, and ride out any near-term volatility with one of the market’s better companies.
But this selloff has reminded investors that valuation matters. And Nvidia has a somewhat questionable valuation — even with the decline from February levels.
A High Valuation
At $249, NVDA stock trades at over 40x fiscal 2020 (ending January) adjusted earnings per share, even backing out roughly $14 per share in net cash on the balance sheet.
To be fair, that multiple is somewhat inflated. FY2020 was an unusual year. Thanks in part to the “crypto hangover” and in part to a pause in data center demand, revenue for the year actually declined 7%. Adjusted EPS fell 13%.
Wall Street expected a rebound — and still does — at least based on published figures. The consensus estimate sits near $8 for FY2021 EPS, and over $9 for FY2022. Neither estimate has moved all that much, likely due mostly to the fact that many firms haven’t updated their numbers yet.
Still, the figures give at least a directional idea of where Wall Street pegged Nvidia’s earnings power before the current crisis. And back near $250, again excluding net cash, NVDA stock trades at more than 25x forward earnings.
A Different Market
That’s not a cheap multiple. Indeed, I saw valuation concerns at the end of 2019, with NVDA at roughly the same price (and forward estimates in roughly the same place).
I don’t see those concerns as necessarily diminished right now. In fact, they may rise for two reasons.
First, there’s going to be a short- and likely mid-term hit to Nvidia earnings. The near-term impact may not be that large: it’s possible that remote work and housebound consumers may increase demand for Nvidia chips. But if a recession arrives, as is likely, that will pressure Nvidia’s earnings.
Again, that 25x multiple is based on estimates that mostly are at least a month old; if those estimates come down, either the multiple has to rise or NVDA stock has to drop, too.
The second issue is that this is simply not the same market. As I wrote in December, Nvidia’s growth relative to its valuation was rather attractive in the context of the market at the time. With the Nasdaq Composite down 17% year-to-date, that’s not nearly as true.
In chips, Intel (NASDAQ:INTC) and Broadcom (NASDAQ:AVGO) have gone from cheap to really cheap (and potentially too cheap). So-called “semicaps” like Applied Materials (NASDAQ:AMAT) and Lam Research (NASDAQ:LRCX) are interesting contrarian buys.
Nvidia’s rival, Advanced Micro Devices (NASDAQ:AMD), has also pulled back, though its valuation isn’t conservative, either.
If an investor is going to enter this volatile market, there are a great number of quality companies with cheaper valuations. Particularly after Tuesday’s bounce, it’s difficult to see NVDA stock as compelling on a relative basis.
The NVDA Stock Pullback
There’s one more broad point worth making. Just because NVDA is cheaper than it was before doesn’t mean it’s cheap.
Indeed, for the market as a whole, this steep selloff is not just about the short-term impact of the response to the coronavirus. It is increasingly clear that many investors, with the benefit of hindsight, see February broad market peaks as being simply too high.
There’s a case that the same is true for NVDA stock. Semiconductor stocks historically have received below-market multiples owing to the cyclicality of the industry; 25x forward earnings is not a below-market multiple.
Yes, Nvidia is growing faster than most chip stocks — and most mature tech stocks as well. But even a premium to the market would suggest that $250 is in the correct range for Nvidia.
At the very least, I’m skeptical this price is a massive opportunity — or close to the best opportunity in the market. Nvidia is a wonderful company. To at least some extent that’s priced in, even after this selloff.
Vince Martin has covered the financial industry for close to a decade for InvestorPlace.com and other outlets. As of this writing, he did not hold a position in any of the aforementioned securities.