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On May 24th, 2023, $750M Nvidia jumped 26% after its earnings release while reporting a 13% year-over-year revenue growth decline. How can a mega-cap stock jump nearly 30% in one day, and how is that possible when revenue growth decelerates?
The answer is the AI boom.
The company designs and builds semiconductors and chips that power data centers with the computation capacity to run generative artificial intelligence applications and large language models. The data centers are foundational to other large tech businesses, such as Microsoft and Google, who want to meet the rush of demand by companies of all sizes for generative AI applications.
Aside from the recent price rally, Nvidia's stock price is no stranger to big jumps in price thanks to similar technological boom cycles such as cryptocurrencies. As a matter of fact, in five years, the stock went from a low of $35 per share in 2018 to a high of $400, generating more than a 1000% return on the day of recording this episode.
The question is, after a 5-year 1000% gain, is it too late to buy Nvidia? Let's talk about that!
I'm Hoda Mehr, founder, and CEO of Stock Card, and on this blog and its accompanying YouTube channel and Podcast show, I share detailed fundamental analyses and interesting investment stories.
This post is part of a series I started a few weeks ago to fundamentally research companies to manage my real-money portfolio. I've already researched Canopy Growth (CGC), Fastly (FSLY), Snap (SNAP) , Shopify (SHOP), Airbnb (ABNB), Unity (U), and JD.com (JD). I'll continue with this series for a few more weeks.
Remember, this content is for education and sharing ideas and not advice to buy or sell any securities.
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Before discussing Nvidia's fundamentals and assessing whether it's time to buy, let's point something out. If you are already investing in the broad market index ETFs such as SPY or QQQ, you already have a big exposure to Nvidia. The stock is the 4th largest holding in SPY ETF and the one I the largest stocks in the QQQ ETF. So no! it's not too late to buy Nvidia, you are already an investor if you are an index investor through your 401K or other similar accounts.
You now need to ask whether you'd want direct exposure to Nvidia too.
The stock has a few interesting fundamental characteristics that can help you decide whether the company has more room to grow. Let's go through the stock's fundamental analysis using our usual fundamental framework:
NVIDIA's Fundamental Analysis
Nvidia makes money by selling computer chips that it designs and builds for other technology companies to run data centers, make video games and computers, and build autonomous vehicles.
Interestingly, Nvidia doesn't manufacture its own chips. It works with Taiwan Semiconductor (TSM) to make the actual chips. But the company develops the technological architecture and the software that makes those chips unique and powerful. There are two important fundamental characteristics in what we just discussed:
NVIDIA's Topline & Bottom Line:
Fundamentally speaking, Nvidia has solid top and bottom lines, two important factors we consider when researching a stock. It's also important to notice that the roughly 30% jump after the recent earnings report comes from the company's forecasted $11B revenue for the next quarter, up from the $7.2B in the year's first quarter thanks to the AI boom which strengthen its topline growth and health.
NVIDIA's Free Cash Flow:
Having a growing topline is good, but better is the company's ability to turn that revenue into cash. Typically, free cash flow is a good indicator that a company's business is working. And Nvidia doesn't disappoint. It generated $2.6B in free cash flow.
NVIDIA's Balance Sheet:
On top of its cash-generating business, it has more than $19B in cash and cash equivalents on its balance sheet against roughly $7B in current liabilities. Nvidia generates cash and has access to enough cash to invest in its future growth without any concerns.
Why Does NVIDIA Want To Issue New Shares?
Talking about cash and balance sheet, there is a rather surprising announcement but the company's SEC filings. It has announced that it may sell up to $10B in new shares at some point, raising additional capital. It's surprising because of all the cash it already generates and holds on its balance sheet. Raising capital doesn't sit well with current shareholders because it increases the number of shares and dilutes the existing shareholders' ownership of the company. Most likely, the company is trying to take advantage of the AI boost to its market cap to authorize share issuance without worrying about the market's negative reaction if it was announced at any other time. My guess is that the new shares can be used to fund the repayment of its current debt, or Nvidia expects it needs much more capital and R&D to stay competitive in the market and that investment is much higher than the cash it has on hand and can generate in the future.
Nevertheless, both reasons don't sit well with me and are a red flag in my books.
Aside from those fundamental metrics, the important question we should discuss now is whether the company deserved the 25% jump on the earnings release day and the follow-on price increases since then.
Today, when I'm researching, Nvidia boasts a 200+ price-to-earnings and 37+ price-to-sales ratio. The Forward price-to-earnings ratio of 53 times indicates the company is expected to be more profitable in the future, but still, these valuations seem quite extraordinary.
To grow into 37 times the P/S ratio in 10 years, Nvidia must grow its revenue by roughly 43% annually all else equal. Nvidia has grown by almost 30% per year compounded in the last few years. But still, 43% compounded annual growth is quite aggressive. Moreover, the generative AI market is expected to grow by 27% annually in the next ten years.
Even if Nvidia grows as fast as the market, it still has a 16% difference between the market growth and the required growth rate to grow into its current valuations. That's HARD to do.
Before summarizing Nvidia's fundamental analysis, and discussing what we should do with the shares, let me invite you to look up Nvidia's Stock Card to research the company on your own. I leave a link to its Stock Card in the show notes.
Better yet, if you don't feel comfortable paying such a high price for Nvidia, we recently launched the generative AI stock list on Stock Card so you can find stocks like Nvidia working in this rapidly growing industry. Type "generative AI" in the search bar and get the list. I leave a link to that list in the show notes too.
NVDIDA's Fundamental Recap
Now, let's recap Nvidia's fundamental analysis:
Is NVIDIA A Buy Now?
Knowing all that, what should we do with Nvidia shares?
I have no doubt NVDA's stock price can and may go up in the coming months. That's how hype-driven stock prices tend to move. They go up until something disrupts their momentum. In the case of Nvidia, any new stock issuance, any disruption to the huge revenue forecast, competitors' announcements, or any supply challenges can qualify as a disruption, and then, it can easily give back its 25% jump in a day.
If you own NVDA as I do, taking some profit off is not a bad idea, especially if you have other or better investment options. And, then, buy the stock back when it comes off the AI hype. Be careful that you may sell, and the stock may still go up. You need to be satisfied that you took some profit, reduced your risk, and can sleep better. Remember, investing is a game of probabilities. The investment return is not an absolute figure. You need to consider how much risk you take to generate a return and whether that risk is justified. After Nvidia's big recent jump, the probability of a decline goes up, and staying away is a prudent strategy.
Also, remember, as we discussed at the beginning, if you are investing in SPY or QQQ index ETFs through your 401K or automated passive investing, you already have massive exposure to Nvidia.
Ultimately, you need to decide whether you are okay to chase the momentum and risk higher drop probabilities or prefer to take some profit off now and wait for the next cycle by adding the stock to your buy-the-deep watchlist. I decided to sell my Nvidia shares, and if you were a Roll with Our CEO portfolio follower, you must have received an update notification.
See you next time!