Nvidia Corp. ($NVDA) shares are likely to fall as the company is overvalued based on its slowing growth rates. The company could be overvalued by as much as 28 percent from current levels. Hypersonic growth is what has propelled NVIDIA shares higher over the years, resulting in a very high valuation. The biggest problem NVIDIA is facing is growth that is slowing tremendously, the only question that remains is how investors will handle those slowing growth rates.
Founded in 2007 by Dov Gertzulin, DG Value is a value-focused investment firm. The firm runs two primary investment strategies, the diversified DG Value Funds and the concentrated DG Concentrated strategy. Q3 2021 hedge fund letters, conferences and more The flagship DG Value Fund was launched in 2007, specializing in middle-market distressed situations and event-driven Read More
NVIDIA’s revenue has risen tremendously over the past year, with year-over-year revenue growth in the mid-50’s and EPS growth around 100 percent. However, those growth rates are about to shrink very quickly over the next few quarters to something much more modest. Because of the slowing growth, the earnings multiple is likely to contract and cause the stock to fall to nearly $140.
Nvidia Is Overvalued
It is not that company will not be able to grow, or that growth will not continue, it has nothing to do with it. It is the multiple investors, and Wall Street is willing to assign to the stock’s price. The slowing revenue and earnings growth of the business cannot support a forward PE ratio of nearly 40, and a growth adjusted PEG ratio of nearly 3, it is simply too expensive. The one-year forward price-to-sales ratio stands at approximately 11, again a very high number. The company is estimated to earn $5.48 in 2020 on revenue of 11.61 billion. Even going out to 2020, one finds the company trading 32 times 2020 earnings, on a price to sales that stands at 9.25. These are valuations that are too high and will result in a stock price that trades either sideways allowing for earnings and revenue to catch up with the stock price, or the stock price simply needs to fall to decrease the multiples. A company growing earnings at 21 percent from 2019 to 2020, should probably trade somewhere around 20 to 25 earnings, to be fairly valued, that would result in NVIDIA stock price to fall about $140 per share, a decline of about 25 percent.
Part of Nvidia’s success has been increasing revenue which was driven by accelerating growth in the data center business, with revenue nearly tripling to $416 million through NVDIA’s second quarter of 2018, from $151 million the year prior. The sequential growth was almost as impressive with revenue rising by over 95 percent in the fiscal fourth quarter 2017, and 39 percent in the fiscal first quarter of 2018. However, that growth came to a halt in the second quarter, with a rise of only 1.71 percent, a sign of peaking growth or increased competition in a highly competitive space.
Automotive Not Coming Through Yet
The other piece of NVIDIA that has had big hopes but has not seen an acceleration as expected is the automotive business, which has seen modest growth. To this point, any revenue growth from the auto business will likely not be enough to compensate for slowing growth in the datacenter. The datacenter revenue growth is left to carry the load because, for the most part, the gaming segment for NVIDIA has slowed as well.
All of this assumes of course that no economic slowdown would result in earnings contracting or the market to revalue its appetite for risk or reassess valuations. If that should happen the downside in the stock is likely to be greater.
NVIDIA is likely to continue to grow well into the future; it is just the company is transitioning from a hypersonic growth company to one that is more normal, that will result in Wall Street re-evaluating just what they are willing to pay for the stock. Which likely means shares NVIDIA could be dead money for a while.
Mott Capital Management, LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.