(Note: The author of this fundamental analysis is a financial writer and portfolio manager.)
Nvidia Corp. (NVDA) shares fell sharply on November 29, with the chipmaker's stock dropping by nearly 7% to roughly $196. But the more significant question: is this the start of a steeper slide or just a blip? Based on the stock's current valuation when compared to peers, Nvidia could be as much as 60% overvalued. Even on a technical a basis one could make a case that the stock could fall nearly 35%.
We have seen this story before—where a stock climbs an exponential wall that could be a giant bubble, as noted in a previous Investopedia article. When applying a valuation that is more in line with other chipmakers, Nvidia shares could be worth less than $80, a decline of about 60% from the stock's current price of $198. (For more, see also: Why NVIDIA's Valuation May Be A Giant Bubble.)
Nvidia Has a Premium Valuation
Nvidia trades at nearly 39 times one-year forward earnings estimates, Texas Instruments Inc. (TXN) trades at about 21, while Intel Corp (INTC) and Broadcom Ltd. (AVGO) trade at multiples closer to 14. The S&P 500 trades at just 19 times one-year forward earnings estimates as well, making Nvidia's valuation very rich at current levels.
Game of Growth
Earnings growth and expectation of future growth drive valuations, or at least it should. According to Ycharts, analyst consensus estimates suggest that Broadcom will grow earnings by 13% in fiscal 2018 to $15.71, roughly in line with its earnings multiple. Analyst estimates for Nvidia show expected growth of 15.5% in its fiscal 2019, but Nvidia trades at nearly 39.
Broadcom has traded with a one-year forward earnings multiple between 8 to 14 over the past two years. Nvidia has seen its multiple expand from roughly 6.5 to over 40. These are two stocks with similar growth rates and the same industry but very different ways of being valued. So is Broadcom a very cheap stock or is Nvidia a very overvalued stock? It is a big thing to consider, because should Nvidia trade at Broadcom's valuation of 14 to 15 times forward estimates, in line with Nvidia's estimated growth rate, and in-line with peers, then shares of Nvidia fall by nearly 61% to just $77. (For more, see also: Goldman Gets Even More Bullish on Nvidia.)
The chart above illustrates the astronomical rise Nvidia shares have seen over the past few years, and while it has not been a straight line higher, the increase is undoubtedly at heavenly heights. The stock's uptrend has now changed its steepness three times just in the past year, each time only growing steeper, indicating the stock is rising at a faster pace. The highest trend line has now been breached, while the second trend line is being put to the test. A break of the second rising trend line will send shares sharply lower, perhaps towards $130, a decline of 35%.
There is no doubting the importance of which way shares of Nvidia go from here, but the market seems to hold Nvidia to a different standard than the rest of the sector. But perhaps it is also possible Nvidia is doing something entirely different and better than the rest of the group that gives Nvidia that edge over its competition, deserving of the premium.
Maybe it will be different this time.
Michael Kramer is the Founder of Mott Capital Management LLC, a registered investment adviser, and the manager of the company's actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of three to five years. Click here for Kramer's bio and his portfolio's holdings. 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. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future performance.