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Red-Hot Nvidia Stock Is Likely To Cool From This Stratospheric Valuation

Nvidia (NASDAQ:NVDA) stock continues to move up, pushing its sky-high valuation even higher. Since my last article on the company a month ago, it has risen $49.69 to $543.61 (as of Oct. 23), or up 10%. That also means that its value metrics are also out of the park.

A racecar featuring Drive PX 2 technology from Nvidia (NVDA) parked.
Source: Steve Lagreca / Shutterstock.com

For example, analysts now put Nvidia stock on a multiple of 60 times earnings for this year ending January and 49 times earnings next year. For example, analysts surveyed by Refinitive and shown on Yahoo! Finance forecast Nvidia will earn $9.10 per share this year and $11.09 next year.

This stratospheric valuation cannot continue much longer without a non-linear jump in the company’s earnings.

What Analysts Are Saying About Nvidia Stock

On Oct. 8, New Street analyst Pierre Ferragu lowered his price target to $400 per share. He put a rare sell rating on Nvidia stock.

His thesis is that the company’s two strong points, data center and gaming chipsets, are likely to experience peak demand in the next two quarters. He believes the stock already reflects this optimism, although there will be one more quarter of strong earnings.

His report says that “overheated expectations lead to disappointment and a correction in the stock.” He is the first one to break from the pack. There is a huge element of groupspeak in the analyst community in stock recommendations. Rarely does anyone ever step out of the consensus like this.

This is similar to a prior article that I wrote on Nvidia stock’s heated valuation, albeit at a much lower level. After all Nvidia stock is now up 131% so far this year and 178% in the last 12 months.

Barron’s called the Ferragu’s New Street report a “bold contrarian call.” To be fair, he points out that Nvidia is the “undisputed leader” in both of these franchises (data center and gaming). However, he thinks the stock will still move higher. Investors should use “an opportunity to take profits or tactically short the stock in the first half of 2021.”

He thinks the stock will fall to about 40x earnings, or twice the S&P 500 index valuation. That implies a correction of about 9x earnings or about $99 from here. This works out to a price target of $444, or a drop of about 18%.

Other Analysts’ Targets Are Lukewarm

For example, Seeking Alpha reports that out of 37 analysts covering the stock 20 are “Very Bullish” and only 2 are “Very Bearish.”

Yet, their average price target is only $565.12, or just 4.0% above the price on Oct. 23.

TipRanks reports something similar. Its survey of 31 analysts shows an average target of $585.96, or 7.8% higher. This does not show a great deal of confidence in the upside of Nvidia stock. This lukewarm enthusiasm for the stock could be a precursor for a fall.

What To Do With Nvidia Stock

I think it is very dangerous to invest at a peak in a momentum play with a high valuation. This is the situation we have now with Nvidia stock.

On the one hand, for example, the company may continue to produce stellar earnings and cash flow. But on the other, most of this positive news is already “in” the stock price at its high valuation metric.

By the way, this issue of high price-to-earnings (P/E) investing vs. low P/E investing is a hot topic for researchers in the past several years.

For example, CNBC reported last June that a BofA Merrill Lynch study found that high P/E stocks have not underperformed in the last 14 years. In fact, low-P/E stocks did worse than high-P/E stocks.

But on the other hand, a research study by Pu Shen, an economist at the Federal Reserve Bank of Kansas City, found that for market averages with high P/E ratios the market returns tended to underperform. Another study found that it depends on whether interest rates are generally falling or not.

Here is my problem with how all of that relates to Nvidia stock. If you were to pay for all of Nvidia’s shares right now, your payback period would be 40 or 50 years. Even if earnings kept on growing dramatically, it would still take 20 or 30 years for payback.

Therefore, for all intents and purposes, the price you pay for a highly valued stock is dependent on whether you can sell it in the future at an equally high valuation.

So, buyer beware with Nvidia stock. You must be very sure that the stock will always have such a high valuation if you buy it at today’s price.

On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.

Mark Hake runs the Total Yield Value Guide which you can review here

Article printed from InvestorPlace Media, https://investorplace.com/2020/10/nvidia-stock-at-unsustainable-pe-valuation-49-times-next-years-eps/.

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