Nvidia (NASDAQ:NVDA) has risen a good deal since my last article in late January. I thought NVDA stock was at full value then, and I still do now … but I think there is more reason now to be cautious.
Of course, the stock kept rising after my article. Now it has an even higher valuation. and as you can probably guess, I still think Nvidia’s valuation looks very rich, at 45 times forward earnings.
And inn case you don’t think the valuation is enough reason to be cautious, I also think that the underlying performance of the company has definitely slowed. I’ll get more into that in a minute.
Moreover, the stock, after rising again, is now at the peak valuation that it had in January. Don’t forget that eventually, I was right — the stock did fall.
Following Nvidia’s FCF Performance
One sign of the chip designer’s peak is that in the first quarter, its revenue fell slightly on a sequential basis. Revenue was $3.08 billion in Q1 vs. $3.105 billion in Q4 2019.
Moreover, its free cash flow (FCF) and FCF margins have been falling for the past two quarters. You can see this in the two tables that I have prepared that illustrate this.
For example, you can see that the company’s FCF peaked in calendar Q3 2019 at $1.537 billion. Its FCF margin also peaked at 51%. You can see this in fig. 2.
Now, cut to the latest quarter. In Q1 2020, Nvidia’s FCF fell to $754 million.
That is almost half of the peak in Q3 2019.
Moreover, the Q1 2020 FCF margins fell to just 24.5%. This is less than half of the Q3 2019 peak margins. Moreover, these margins are even below those from Q1 2019, a year ago.
So, why is NVDA stock still flying so high?
What Analysts Are Saying About NVDA Stock
Barron’s says it still isn’t too late to buy the stock. They cite the demand for the company’s graphics processors from cloud operators. They also cite investors’ enthusiasm for the company’s purchase of Mellanox. For example, they cite sources that say that data centers want the faster graphics processors rather than traditional Intel (NASDAQ:INTC) chips.
The problem is the stock trades for 45 times forward earnings for the year ending January 2021. Even looking forward to January 2022 earnings, NVDA still trades at a very high ratio of 36 times earnings.
That is very high. I am definitely going against consensus here.
For example, Benzinga came out with an article after the Q1 earnings release in late May showing that many analysts expect NVDA to rise above $400 per share.
The problem I have with these high valuations is that the company must perform perfectly. In the high-tech world, there’s always another competitor right around the corner. Any hiccup in earnings growth will push the stock lower.
What to Do With NVDA Stock?
Maybe you shouldn’t listen to me. I was sort of wrong the last time I said that the stock price had peaked. It went up further … but eventually went down. So maybe I was right?
By the way, I never wrote an article on NVDA when it had slumped. That might also be another reason to not listen to me.
I suspect that most people like to see a stock rise, even though they know the valuation is out of whack. For example, it might be easy to write off my charts above. That is the past. Everyone knows that margins were going to be lower from lower demand due to Covid-19.
That is true. But I still feel that analysts are not concerned enough about the stock’s high valuation.
So I will give you one last idea to consider.
Buying a stock with a 45 time P/E or even a 34 times P/E implicitly implies you have to own it a long time. If you owned the whole company at that price, and could not sell to anyone else, you would have to wait 34 years before your principal would be earned back.
That is a long payback period risk that most business people would not be willing to risk if it were a private company. But for some reason, people are willing to do it with public stocks.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here.
