As a long-time Nvidia (NASDAQ:NVDA) bull, it was tough for me to say last week that it may be time to pump the brakes on a red-hot NVDA stock that is up 212% in 2020 alone.
But that seems like the smart thing to do.
Nvidia is a great company, on the cutting edge of creating next-generation GPUs which will power all of tomorrow’s most important industries, and those solid fundamentals create visible runway for the company to sustain robust revenue and profit growth for a lot longer.
But all of that is already priced into NVDA stock… and then some.
After all, this is now a $320 billion company. The global semiconductor market projects to do about $430 billion in sales this year.
In other words, Nvidia stock is running into some significant valuation friction. And for that reason alone, it’s not worth chasing the stock up here.
Here’s a deeper look.
Great Fundamentals and NVDA Stock
There’s no denying one simple truth.
Nvidia is supported by great long-term growth fundamentals.
Self-driving. Cloud computing. Artificial Intelligence. Internet-of-Things. Augmented Reality. Virtual Reality. These are the industries which represent the future of our world, and all of them are built on the back of CPUs and GPUs.
Only a few companies make great CPUs and GPUs: Nvidia, Intel (NASDAQ:INTC) and Advanced Micro Devices (NASDAQ:AMD). In that group, Nvidia is the head-and-shoulders leader when it comes to next-gen GPUs, and therefore, reasonably projects to sustain robust end-market demand from self-driving, cloud computing, AI, IoT, etc over the next several years.
As that happens, Nvidia will sustain 10%-plus revenue growth. Gross margins will head higher, too, because strong demand will drive favorable price hikes. Operating margins will head doubly higher, because of scale driving positive operating leverage.
Net net, Nvidia has high visibility to huge revenue and profit growth over the next 5 to 10 years.
This big growth explains why NVDA stock has rallied so much over the past few years.
The Valuation Is Too Rich
At the end of the day, though, valuation matters. And while the upside from strong fundamentals has consistently outweighed the downside from a stretched valuation for NVDA stock over the past few years, that no longer remains true today.
Nvidia stock’s valuation is at a point where upside potential is limited, and downside risks are significant.
There are a few ways to look at this.
First, the multiples are insanely stretched: 25-times trailing sales, 100-times trailing earnings, 60-times trailing cash flow, 23-times book value. Those are multiples you never see in the cyclical, capex-heavy semiconductor industry.
Second, the comps don’t add up. After all, this is a $320 billion company with $13 billion in trailing sales, while Intel is a $220 billion company with $79 billion in trailing sales. Thus, Nvidia is being valued at a 50% premium to Intel, yet Intel has 500%-plus more sales.
Third, the long-term growth prospects don’t support current prices. Earnings this year are expected to come in around $9 per share. In a best-case scenario, I see that number hitting $40 by 2030. Based on a 20-times forward earnings multiple and an 8.5% discount rate, that implies a 2020 price target for NVDA stock of under $400.
Thus, no matter which way you slice it, NVDA stock is expensive. Too expensive.
Sure, this rich valuation can last forever. So long as Nvidia executes flawlessly. But it’s tough to execute flawlessly in a viciously competitive, exceptionally cyclical semiconductor industry with volatile margins. And, even if the company does execute flawlessly, potential upside in NVDA stock is limited by today’s already stretched valuation.
Bottom Line on NVDA Stock
I have loved Nvidia stock for several years. It’s been one of my favorite growth stocks in the market.
But the risk-reward on NVDA stock just no longer makes much sense, in that it skews heavily towards the downside with minimal upside potential in an “everything goes right” scenario.
For that reason — and that reason alone — I think it’s time to pump the brakes on NVDA stock, and take some profits off the table.
Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been recognized as one of the best stock pickers in the world by various other analyst and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, he did not own a position in any of the aforementioned securities.
