Avoid Nvidia Stock at Its Sky-High Valuation

Nvidia (NASDAQ:NVDA) keeps soaring, but it is now reaching a stratospheric valuation. NVDA stock is trading at over 50 times this year’s expected earnings. This is much higher than its average price-earnings ratio of 40 times over the last seven years. In fact, it is even higher than the last five years, which have had an average of 46 times earnings.

a Nvidia semiconductor chip
Source: Hairem / Shutterstock.com

However, even if you estimate that earnings next year will be over 21 times higher, the price-earnings ratio is still high at 41 times expected earnings.

Part of the reason is that one of Nvidia’s semiconductor competitors is faltering. Intel (NASDAQ:INTC) just reported that it is going to delay its 7-nanometer microprocessor chip for another six months. This was supposed to be its next-generation chip. Market share is clearly heading to both Nvidia and Advanced Micro Devices (NASDAQ:AMD).

Nvidia now has a $256 billion market capitalization compared to Intel’s $210 billion market valuation. That is because Intel’s market cap fell 16% in one day on July 24. By the way, AMD’s market cap is just $81 billion.

What Analysts Say About Nvidia

In fact, Cowen analyst Matthew Ramsay believes the race has opened up. He wrote that Intel will not be able to “catch” AMD and Nvidia’s “silicon process leadership in any bounded time frame as it stands now.”

Barron’s Jack Hough recently wrote that Nvidia’s chips for data center applications will overtake its video gaming chip business this year. Its data center chips are mainly designed for artificial intelligence applications. That is the future for the chip business.

For example, analysts predict its AI-related business will top $6.5 billion in sales, against just $6.1 billion for its video gaming chip business.

Hough quotes Nvidia CEO Jensen Huang as saying, “People thought we were a video game company. But we’re an accelerated computing company where videogames [sic] were our first killer app.”

Ramsay, the Cowen analyst, raised his Nvidia price target from $410 to $475. He based this on multiple factors, including the company’s recent acquisition of Mellanox.

AI and Mercedes-Benz

Chris Rolland, an analyst at Susquehanna Financial Group, argues Nvidia’s advantage is its software development for parallel processing. This is where software performs many tasks at the same time. He says Intel rules in serial processing, one task at a time.

As TechCrunch’s Kirsten Korosec points out, this is the core of what is Nvidia is doing for Mercedes-Benz with its self-driving, “software-defined” cars. In late June, the two companies struck a deal to upgrade a new generation of vehicles. It will eliminate complexity while boosting vehicle performance and automated driving capabilities.

The two companies will jointly develop the AI and automated vehicle applications that include Level 2 and Level 3 driver assistance functions, as well as automated parking functions up to Level 4. Level 4 requires no human intervention, according to the Society of Automobile Engineers (SAE).

What NVDA Stock Is Worth

As I mentioned earlier, NVDA stock has traded at a historical 46 times price-earnings ratio over the past five years. If we apply that ratio to the forward 2021 earnings, this gives a potential target price of $457.58 per share. That is only 10% above the July 27 price of $416.86.

However, this ignores some other important measures of value. For example, the average P/E ratio of eight other chipmakers comes in at just 22 times earnings. In other words, the market is valuing Nvidia over twice the average. It may be that the company is worth this higher valuation. After all, AMD trades at a 45 times forward P/E valuation.

Or maybe Nvidia has much higher margins than its peers. Nvidia made $976 million in operating income on $3.1 billion in sales in its latest quarter. That is a margin of 31.5%. Intel made $5.7 billion on $19.7 billion in sales. That is a margin of 28.9%. And Advanced Micro Device’s recent quarterly operating margin was only 9.8%, based on operating income of $177 million on sales of $1.8 billion.

Bidding Up the Stock

So hopefully you see my point. The market has bid up NVDA stock based on popularity, momentum and growth. In fact, if you average two other methods of evaluating the stock, its target price is much lower than today’s price. As I mentioned, the peer-based P/E ratio is just 22 times earnings.

In addition, Nvidia’s historical dividend yield is actually higher than today’s dividend yield of just 0.16%. Its historical yield is 0.35%. Therefore, the target price based on this measure is just $182.86.

The average of all three methods of valuing NVDA stock is $286.70. This is 30% below today’s price.

What Should You Do With NVDA Stock?

I have warned that Nvidia stock is overvalued in other articles. So far, I have been wrong. Maybe this time I am right. Who knows?

But my arguments are still sound. On a statistical basis, NVDA stock looks expensive. To own this stock you have to pay somewhere between 40 and 45 years of expected earnings to be a shareholder. That is a high price to pay for popularity and growth.

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

Article printed from InvestorPlace Media, https://investorplace.com/2020/07/nvidia-nvda-stock-soaring-sky-high-valuation/.

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