Nvidia Stock (NASDAQ:NVDA)
Due to the company’s dominant position in the GPU market and the use of its technology in numerous AI initiatives, Nvidia’s (NASDAQ:NVDA) stock has surged by around 60% since the start of 2023. This shows how concerned people are about AI. Nevertheless, given that GPU sales are currently dropping quickly and that geopolitical issues as well as Nvidia’s vulnerability to the Chinese consumer market damaged the firm’s performance in FY23, it is difficult to see why the stock of the company could be rising so sharply at this moment. It’s challenging to imagine how Nvidia stock might climb and trade at more than 50 times current sales merely because of the AI hype, even though there will be a need for projects related to AI in the future.
The Hype Surrounding AI Has Arrived
A few weeks ago, Nvidia released its Q4 earnings report, which showed that the company generated $6.06 billion in revenue during the quarter, a 20.8% year-over-year decline but $30 million more than what the Street had anticipated. Nvidia’s stock increased despite the fact that its sales decreased year over year since the gaming industry improved, the data center industry grew, and the market was obsessed with everything AI-related.
Without a doubt, Nvidia will gain a lot from future investments in and developments in AI, as its GPUs will probably continue to run huge language models like ChatGPT. The current AI competition between Google (NASDAQ:GOOGL), Microsoft (NASDAQ:MSFT), and others is also anticipated to increase demand for Nvidia’s A100 and H100 AI GPUs. The Street predicts sales growth of 10.2% year over year, and Nvidia’s fiscal year projection was greater than expected. This gives us even more reasons to be optimistic about the future of the business.
But, if the focus on AI in the market is the main factor, Nvidia’s shares are unlikely to keep climbing for very long. The value of the shares exceeds 50 times their sales. It was therefore entirely rational for management to submit a $10 billion mixed shelf offering during the recent upswing. It’s challenging to imagine Nvidia’s stock continuing to increase rapidly in the short to medium term once the AI hype train stops. This is especially true given the current state of the macroeconomic environment, which is unstable and full of geopolitical risks that have already hurt the company recently.
Does the AI Premium Make Sense?
Although Nvidia may in the long run profit greatly from the development of AI, the company is currently dealing with a number of problems that may cause it to perform poorly in the near future and make it challenging to maintain its existing value.
The company’s current biggest problem is that it has too much inventory. The firm held a record $5.2 billion in inventory at the end of January, up from $2.6 billion a year earlier, according to the most recent statistics. On the other hand, decreasing demand in Q4 caused GPU shipments to drop 35% year over year, which was the main factor in Nvidia’s steep revenue reduction in the prior quarter. Nvidia would most likely need to provide GPU discounts to sustain demand in order to make up for the risks of having record levels of inventory at a time when sales are decreasing. Lower margins and worse performance than expected could be the outcome of this.
As Sino-American ties worsen and the White House weighs further restrictions on chip exports, the company is still dealing with geopolitical risks that are expected to put further pressure on its stock price. I remarked a few months ago that one of Nvidia’s main problems is its dependency on China, which accounts for more than 20% of its sales. The most recent set of chip limitations implemented by the Biden administration has already prevented businesses like NIO (NIO) from purchasing A100 processors from Nvidia, which could have generated $400 million in revenue in FY23. Nvidia won’t be able to completely distance itself from China in this new geopolitical context, according to claims that it will likely be unable to sell technology to Huawei. This indicates that the company will continue to experience financial troubles. So, it is significantly more challenging to explain why its stock unexpectedly increased.
I decided to update my DCF model, which pegged Nvidia’s valuation at $138.69 per share in September before the White House rules went into force and ChatGPT had not yet been introduced. The adjusted model below has revenue assumptions that are largely in line with what the market anticipates. On the other hand, the EBIT assumptions are the same as in the earlier model and are on the high side. Even if the firm pays less than that, the tax rate of 5% was purposefully fixed. Government aid and subsidies may prevent it from rising much in the foreseeable future. Averages from prior years represent D&A and capital expenditures as a percentage of sales, but the change in net working capital is still positive and is limited to $2000. At the end of the term, the WACC and growth rate are the same as in the earlier model.
Nvidia’s fair value, according to an updated model with more optimistic assumptions, is estimated to be $172.68 a share, which is still considerably less than the current market price of about $230 per share.
Yet there are a few things to take into account. To begin with, Nvidia hasn’t recently been a valuable investment. Even when selling at sky-high prices, the company’s shares were attractive to investors due to how quickly it was growing. Yet, there is a case to be made that as more money is put into the AI industry due to the ongoing competition between Big Tech, the most cutting-edge GPUs from Nvidia will continue to be in high demand.
The problem is that it’s challenging to imagine how Nvidia’s stock could continue to rise quickly in the coming months based only on the market’s enthusiasm for AI. It is challenging to defend the current price given the rise in geopolitical concerns and the rise in inventory at a time when total sales are down.
There is no denying that artificial intelligence is the upcoming big thing, and in the near future, a lot more money will be invested in this field. There is also no doubt that Nvidia will gain a lot from all of this since it dominates the GPU industry and because its GPUs will be crucial in enabling a variety of AI programmes to scale up.
Yet, it’s also conceivable to assume that the recent rise in Nvidia stock was caused by the market’s obsession with artificial intelligence (AI). Nvidia’s shares are predicted to decline since they already trade at a very high price and GPU sales are dropping, which will not help maintain the momentum when the AI hype train loses steam and the market switches to a new fashionable topic. It is clear that now is not the time to purchase Nvidia’s stock at current levels given that the firm is subject to significant geopolitical challenges, which have already affected its performance in FY23.