The artificial intelligence (AI) trade has whipsawed this year, and so has its flagbearer Nvidia (NVDA). The chip-designing giant hit its record highs last month and has since lost 15% from those levels. As of last week’s closing prices, the stock’s year-to-date returns trail both the tech-heavy Nasdaq 100 Index ($IUXX) and the diversified S&P 500 Index ($SPX).
Nvidia’s performance would seem at odds with its financial results, though. For instance, its revenues more than doubled in the most recent reported quarter, and its guidance for fiscal Q3 implies they will nearly double again. For the next fiscal year, Nvidia guided a 70% revenue growth, which is astonishing considering the high base. Moreover, at a time when companies are hard-pressed even to guide for the next quarter, Nvidia went out of its way to provide a forecast for the next fiscal year.
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Following Nvidia’s fiscal Q2 earnings release in August, I noted that despite the strong growth and reasonable valuations, Nvidia wasn’t a “buy.” With NVDA coming off those levels, let’s explore the stock's outlook.
www.barchart.comWhy Has NVDA Stock Been Falling?
The recent weakness in NVDA could be attributed to the weakness in the AI trade. Incidentally, all the Magnificent 7 names, which happen to be Nvidia’s biggest customer set, plunged following their September quarter earnings, in part due to growing anxiety over their AI capex. Since much of this capex lands in Nvidia’s coffers, the stock too fell alongside. To make things worse, Intel’s (INTC) tepid Q4 guidance led to a sell-off in other chip stocks, which also put pressure on NVDA.
On a broader level, there are concerns over the sustainability of Nvidia’s growth since customers like Alphabet (GOOG) (GOOGL) and Amazon (AMZN) are working on their own chips. They are not only using them internally but also aggressively scouting third-party customers. Selling chips to third parties would help hyperscalers justify their burgeoning AI capex and offset some of their cash burn.
Then there are fears over “circular financing” and off-balance-sheet financing. So, we have Nvidia investing in companies that buy its chips, while cloud companies like Amazon, Microsoft (MSFT), and Alphabet — the three biggest players in that order — are investing in AI startups that have developed into their biggest cloud customers, driving much of the incremental growth. While Nvidia CEO Jensen Huang is dismissive of the very term circular financing and, during the Q2 call, said that he regrets not investing in these companies early, terming it an “once-in-a-generation opportunity,” at least a section of the market is getting apprehensive over such transactions.
Off-balance-sheet financing is another concern, and Nvidia has been providing credit guarantees for its customers’ data centers. There are reports that Nvidia is in talks to provide credit guarantees to Nscale for a data center that Anthropic would use. Such deals add a layer of risk for Nvidia investors and would be catastrophic if AI actually turns out to be a bubble and goes bust. That, however, is not my base case assumption, and while there are visible signs of exuberance in AI, the technology holds a lot of promise.
How to Play NVDA Stock?
I believe the sell-off in NVDA stock has gone a bit too far and see the recent pullback as a buying opportunity, particularly as the company heads into its Q3 earnings call. While Nvidia’s recent quarterly earnings have been followed by a decline in its stock price despite the company delivering a “beat and raise” quarter, the setup looks nice to me ahead of the Q3 report.
At around the $200 price level, Nvidia is offering an attractive entry point with a price-to-earnings multiple of around 23x. While Nvidia has had a dismal run this year, I believe the stock should make up for it in the final two months of the year, and I see it ending the year higher than these levels.
On the date of publication, Mohit Oberoi had a position in: AMZN , GOOG , NVDA . All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
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