Since early 2016 Nvdia Corp. (NASDAQ:NVDA) has gone from being a relatively obscure designer of graphics chips into one of the bull market’s true stars.
At its Oct. 5 opening price of over $181 per share, the stock was trading at 51 times earnings and more than 15 times its trailing year revenue of $6.9 billion.
With a market cap of $108 billion the 25 year-old company is now one of the giants of the semiconductor industry, worth almost $20 billion more than venerable Texas Instruments Inc. (NASDAQ:TXN), which co-patented the integrated circuit with Intel Corp. (NASDAQ:INTC) almost 60 years ago. TI and Intel also own their own manufacturing plants, a capital cost NVDA does not bear.
I wrote recently Nvidia could become more valuable than Intel, although Intel remains $74 billion ahead for now.
While Nvidia is a great company, investors buy the future rather than the past. The question for today is, how high is too high?
Irrational Exuberance for NVDA Stock
At its current price Nvidia has blown through the usual metrics by which we measure chip stocks. Intel, for instance, is worth just 15 times its earnings, and carries a 34 cent per share dividend yielding 2.77% to boot.
The company carries its high price because of the cloud. The market assumes that its chips will be at the heart of the first cloud upgrade cycle, as cloud companies rush to support artificial intelligence (AI) and deep learning.
This is true, but Intel is the chief cloud supplier and their graphics capability is not too shabby. Their latest “Coffee Lake” chip announcement sent NVIDIA shares down 3.8%. Coffee Lake graphics are integrated, they are part of a chip that can run a PC by itself, while NVIDIA’s GEForce chips are discrete, a sub-system to a central core. Will cloud companies see that difference, or design around it?
For now, Nvidia is ahead, supplying all the major players in a cloud market that is due to triple in size, to $493 billion, by 2026. But the cloud upgrade cycle is built around AI, not pure graphics, and there are at least 15 companies now working to out-do Nvidia in AI, led by Alphabet Inc. (NASDAQ:GOOGL), and like Nvidia none of these companies must build a manufacturing plant to compete.
Any small company with a breakthrough is bound to attract the giants, and Intel will launch new graphics chips dubbed “Lake Crest” soon, based on technology bought with Nervana Systems last year. Cloud companies traditionally don’t go for “bleeding edge” hardware, preferring to buy “good enough” in quantity – that is how they developed in the first place.
High High the Moon?
At its current valuation Nvidia doesn’t have to lose for investors to lose. Just win a little less often than it is winning now.
There is no doubt that Intel represents better “value” than Nvidia, but Intel is up only 8.5% so far in 2017 while Nvidia is up almost 70%. Nvidia revenues grew 40% in 2016, compared with the previous year, but they are only on pace to top that performance by 20% this year, unless the third quarter report shows considerable acceleration.
That report isn’t due until Nov. 9, and analysts are expecting revenue of $2.36 billion, with earnings of 94 cents per share, which is only 18% more revenue, and 10% more net income than a year ago. It is very possible Nvidia could beat that number by a lot, but even $2.5 billion in revenue is 25% growth.
Every company grows more slowly over time. The law of large numbers gets everyone. As Nvidia growth slows naturally, so too with the stock price. It is going to top out.
Dana Blankenhorn is a financial and technology journalist. He is the author of the historical mystery romance The Reluctant Detective Travels in Time, available now at the Amazon Kindle store. Write him at danablankenhorn@gmail.com or follow him on Twitter at @danablankenhorn. As of this writing he owned no shares in companies mentioned in this article.
