Nvidia Stock: It Could Be A Buy In A Couple Of Months (NASDAQ:NVDA) (2024)

In November 2021, I called Nvidia (NASDAQ:NVDA) a meme stock overvalued by 50 percent for the next ten years. It is now down 40 percent from its peak and has performed much worse than the S&P 500. Importantly, I don't have anything against the company per se. On the contrary, I am a big fan of Nvidia and its management. For example, I recommended buying the stock in January and May 2020.

After the recent share price correction, the share looks somewhat more interesting again. Nevertheless, I think it is still too early to buy.

Nvidia - a monster of a company

Nvidia is a monster of a company, and we all know the famous Warren Buffett quote that he would rather pay a fair price for a good company than a good price for a middle-class company. Nvidia is such a good company. The speed at which the two segments "Graphics" and "Compute and Networking" are growing is impressive. For example, the Graphics segment generated $9.8 billion in revenue in 2021. With a margin of 46 percent, this left more than 4.6 billion in profit. "Compute and Networking" generated revenue of USD 6.8 billion and a profit of USD 2.5 billion in 2021 (margin of 37 percent). Then in fiscal 2022, both revenue ("Graphics": $15.8 billion; "Compute and Networking": $11.04 billion) and margins increased between 4 and 5 percentage points ("Graphics": 53 percent; "Compute and Networking": 41.6 percent).

Everything looks like the impressive growth will continue. In the following, I have compiled the opinions of analysts surveyed by FactSet for the most important key figures EPS, adj. EPS and operating cash flow.

Numbers in () are numbers of analysts asked by FactSet Research

We see that the number of forecasts decreases the further we look into the future. In addition, the range of the estimates also varies more and more. Nevertheless, the number of forecasts allows us to take an average value. This results in the following overview, which shows the expected growth for Nvidia.

The trend is accordingly clear. Since the company pays out less than 5 percent of its profits in dividends, there is much cash hanging around. Currently, Nvidia's cash, cash equivalents, and marketable securities are $21 billion (up from $11.56 billion). With interest-bearing debt of just $11.6 billion, Nvidia's balance sheet is extremely solid.

Accordingly, the company has enough cash to continue the capital-intensive competition for new technologies and to buy external growth if necessary. However, such external growth as the failed Arm acquisition is unnecessary since Nvidia is well-positioned for the future. Like Qualcomm (QCOM), for example, Nvidia is expanding the application field of its products into more and more markets and areas, both in terms of software and hardware. This "eco-systemization" of its product portfolio creates a moat against competing products and secures long-term revenues and cash flows.

Nvidia refers to a $1 trillion market made up of the following segments:

1. Gaming ($100 billion)
2. Nvidia AI Enterprise Software ($150 billion)
3. Omniverse Enterprise Software ($150 billion)
4. Automotive ($300 billion)
5. Chips & Systems ($300 billion)

To achieve these goals, a good pipeline is needed, and this is indeed well filled at Nvidia. The company recently signed new partnerships for the automotive sector, e.g. starting in calendar 2025, all new Jaguar and Land Rover vehicles will be built on the Nvidia DRIVE platform, boosting the footprint the company already has in the automotive sector. Nvidia will also continue to benefit from the fact that GPUs are superior to CPUs in the data center sector. Right now, Nvidia has an 80.6 percent market share in the AI-focused data center chip market. As the annual market revenue is expected to grow by a factor of nine between 2019 and 2026, Nvidia will likely leverage its leading position to continue to profit from this massively growing market. Meta (FB), for example, decided to use Nvidia's GPUs for its new AI supercomputer. And then, of course, there's the Omniverse. It is still a buzzword, but the potential revenue streams are quite obvious, and the first product areas from which Nvidia can profit in the future are already forming here. The company has presented the Isaac Autonomous Mobile Robot ("AMR") platform for digital twin applications in the $9 trillion heavy logistics industry. The areas of application are not limited to logistics, however, but are generally conceivable in industry, house construction, architecture, interior design, retail, etc.

In short, the outlook for the future is bright, and the past years illustrate what an excellent path Nvidia's management is on.

And after the recent correction, many investors who missed the last rally now may think that this is a perfect moment to prepare for the next peak. And while my long-term view is that the sell-off in Nvidia stock has significantly improved the risk/reward ratio for the next 10 to 15 years, I expect we'll see even lower prices before then. I don't have a crystal ball either and could be wrong, but I don't see any reason to buy the stock yet despite the recent correction. I will explain why in a bit more detail below.

Correction isn't over yet

For once, it's worth zooming out and taking a slightly broader view of the market. I don't think anyone can seriously deny that tech stocks have gone into an exaggeration to the upside since the Corona crash. You can already see that in the way that multiples have been going higher and higher - evidence that the stock price is getting further and further away from operating performance.

However, markets tend to undergo downward exaggerations just as violently as previous upward exaggerations. Behind this is the stock market wisdom that what flies high falls just as low. It is no different for stocks, as the following overview shows.

For the Nvidia stock, there is a significant risk that the current correction is just the beginning. This is also supported by the fact that the stock is still overvalued. Nvidia has not been a growth stock since this year, yet market participants are pricing the stock with earnings multiples of over 40, which is far above historical multiples. But even beyond the earnings, Nvidia is valued at a P/S of almost 18.5, twice as high as the average of the last ten years. Accordingly, Nvidia is not only overvalued according to what I would call "traditional valuation" for growth companies but also compared to its historical valuation. Despite the correction, these are already clear signs that speak for a relatively poor risk/reward ratio.

After all, this high valuation creates a high drop-off point. Investors often forget that growth is not always guaranteed. Even companies like Nvidia can go through weaker periods. For example, in Q4 2022, automotive revenue fell for the second quarter in a row. In Q2 2022, Nvidia generated revenue of $152 million, while in Q4, it was only $125 million (down 7 percent q/q and 14 percent y/y). It is therefore not only a pure valuation risk but also an operational performance risk, which - mind you - exists for every company.

Discounting the cash flow in a "rising-rates environment"

In addition, the interest rate markets are currently showing momentum that many investors (especially the central banks) did not expect a few months ago. Massive interest rate increases are now a foregone conclusion. The future cash flows have to be discounted accordingly. Investors massively underestimate the impact of such interest rate hikes. We already see Nvidia's cost of equity (CEO) and the weighted average cost of capital (WAAC) skyrocket above 2019.

WACC and COE may continue to rise. Accordingly, investors will have to discount future cash flows heavily. So let's take a bullish scenario for Nvidia and continue to assume massively increasing sales and margins but increase the discount rate to 12 percent.

Even based on these bullish assumptions, which in my view are too bullish, the stock is still overvalued by 20 percent.

Conclusion and challenges to my thesis

The recent correction has improved the risk/reward ratio somewhat. In my view, however, we are still a long way from being able to speak of an attractive investment opportunity. Nevertheless, I would now withdraw my bearish rating and change it to neutral. Thus, the stock has already reduced a significant part of the overvaluation I outlined in November. In addition, I am willing to give Nvidia a premium given its operating performance. However, it is not yet enough for a "buy" rating as the stock is still overvalued by between 20 percent and 30 percent.

I could be wrong, of course. Perhaps we will never see these prices, and subsequently, April 2022 will be the last buying opportunity before a new massive rally. Overvaluation, for example, can be reduced within a few years through excellent operating performance. In addition, Nvidia's portfolio is highly diversified; weak quarters in individual business areas, as is currently the case in the automotive sector, do not have a major impact when other business areas such as data centers are growing massively. And if perhaps the interest rate turnaround fails to materialize or the market is pricing in more than is actually coming, then the next tech rally will drive Nvidia up and skeptics like me will remain on the sidelines.

Nevertheless, the decisive factor for me is the risk/reward ratio. And here, I currently see no reason to act quickly despite the current drop in share prices. Accordingly, I remain on the sidelines for now, but as I said, I am changing my rating from bearish to neutral.

Runner of the TEV Blog | Private InvestorI am a long-term oriented investor and in my early thirties. I hold a law degree and a doctorate in law and love investing and talking about my and others' investments. I regularly write about my research and investments on various investor platforms and the TEV Blog. **My articles represent my opinion only and in no way constitute professional investment advice. It is the responsibility of the reader to conduct their due diligence and seek investment advice from a licensed professional before making any investment decisions.**