At $420, What Are The Risks For Nvidia Stock?

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Nvidia stock (NASDAQ: NVDA)  has done exceedingly well this year rising by almost 3x since early January. There’s a lot going on for Nvidia. Technology companies and developers have been rushing to deploy generative artificial intelligence (AI) into their applications following the success of OpenAI’s ChatGPT chatbot and this is driving a windfall of sorts for Nvidia, whose high-end graphics processing chips, such as the A100 and H100, remain the go-to products for AI workloads. Over the most recently reported quarter, Nvidia’s revenue roughly doubled year-over-year to $13.51 billion, beating guidance of $11 billion. Nvidia is also turning incredibly profitable due to the AI surge. Net income rose over 5x compared to last year to $6.7 billion, as gross margins jumped to 71.2% from 45.9% in the year-ago quarter. The momentum is expected to hold up. For Q3, Nvidia has guided that revenues could grow by 170% year-over-year. Nvidia is also in a relatively favorable position with respect to supply.  The company has substantially larger commitments from its suppliers to meet demand and has indicated that it expects supply to increase each quarter through next year.

NVDA stock had a Sharpe Ratio of 1.1 since early 2017, which is higher than 0.6 for the S&P 500 Index over the same period. Compare this with the Sharpe of 1.2 for the Trefis Reinforced Value portfolio. Sharpe is a measure of return per unit of risk, and high-performance portfolios can provide the best of both worlds.

That being said, at the current market price of about $420 per share, there are potential risks that investors should be aware of. While Nvidia remains in pole position on the market for AI chips, traditional chipmakers such as Intel and AMD are investing significantly to catch up in this space given the high stakes. AMD recently unveiled the MI300X chip which is targeted specifically at large language model training and inference for generative AI workloads.  The chip’s specs, which include 192 gigabytes of high-bandwidth memory, well ahead of the 120 GB found on Nvidia’s H100 data center GPU, indicate that it could compete favorably with Nvidia. Moreover, big tech players like Google are doubling down on AI and machine learning-related silicon. For example, Google’s Tensor Processing Units are specialized integrated circuits focused on machine learning. Although Nvidia’s chips are superior in terms of overall performance at the moment, with the company also using proprietary software and programming languages to better lock in customers, competition will make Nvidia’s current growth and abnormally high margins unsustainable.

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With AI viewed as a transformational technology, governments are looking to regulate the sector. The Biden administration has placed export restrictions on the export of advanced chips such as the  A100 and H100 GPUs to China. While Nvidia has tweaked the design, offering A800 and H800 AI chips that play within the rules to the Chinese market, this does underscore the risks for the company given that data center sales to China account for between 20% to 25% of the company’s overall data center sales. The U.S. government also recently expanded the ban on high-end AI chips to include some countries in the Middle East. While Nvidia doesn’t see a material impact from these bans, geopolitical risks could remain a factor for the company.

Nvidia’s valuation is also relatively lofty. The stock trades at about 40x FY’24 earnings and about 18x revenue. This compares to the broader semiconductor industry average price-to-sales multiple of about 4.5x. Tesla stock didn’t trade at P/S multiples of these levels at its peak in 2020-2021. Although the company has growth on its side, with sales likely to roughly double this year per consensus estimates, this could prove a risk for investors if growth falters for any reason, particularly in the current high-interest rate environment. We remain neutral on Nvidia stock with a valuation of $408 per share, which is slightly below the current market price. See our analysis on Nvidia Valuation: Is NVDA Stock Expensive Or Cheap? for more details on what’s driving our price estimate for NVDA stock. Also, see our analysis of Nvidia Revenue for a closer look at the company’s key revenue streams.

 Returns Sep 2023
MTD [1]
2023
YTD [1]
2017-23
Total [2]
 NVDA Return -14% 189% 1482%
 S&P 500 Return -4% 13% 93%
 Trefis Reinforced Value Portfolio -6% 24% 534%

[1] Month-to-date and year-to-date as of 9/26/2023
[2] Cumulative total returns since the end of 2016

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