Key Takeaways
- The gap between Nvidia’s earnings and share performance expanded on Thursday as shares slumped even as the AI chipmaker forecast continued strong growth throughout this year.
- Investors are increasingly unsure that the AI infrastructure spending underpinning Nvidia’s growth is sustainable; general AI anxiety is also acting as a headwind for tech stocks.
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Nvidia’s revenue is skyrocketing. Its margins are holding up. Its stock is tumbling. What gives?
Nvidia on Wednesday afternoon blew past fourth-quarter earnings estimates and forecast revenue growth will accelerate in the current quarter. Analysts all over Wall Street raised their earnings estimates in kind. UBS analyst Timothy Arcuri raised his earnings estimates for the next two fiscal years, while Bank of America’s Vivek Arya lifted his through the next three.
Yet shares of Nvidia (NVDA) fell more than 5% Thursday, erasing the stock’s year-to-date gains and putting it more than 10% off its October all-time high.
Why This Is Important
Nvidia stock has accounted for a sizable share of the overall stock market’s returns in recent years. But in recent months, the AI bellwether’s stock has lost its momentum despite a booming business, underscoring the uncertainty looming over even the surest of AI bets.
For most of the past three years, Nvidia stock skyrocketed in lock step with the chip maker’s profits. Both its stock price and earnings increased twelvefold between the end of 2022 and the middle of last year. Then something changed. In the five months preceding Wednesday’s earnings report, Nvidia stock traded sideways while earnings estimates increased nearly 40%, according to a recent Goldman Sachs note.
Heading into Wednesday’s earnings report, Nvidia stock traded at a handsome discount not just to itself historically, but also to tech peers. Nvidia’s price/earnings-to-growth ratio (PEG), which factors expected earnings growth into the standard price-to-earnings valuation metric, is about 0.5, the lowest of the mega-cap tech stocks, according to Bank of America. The rest of the group’s PEG ratios range from 0.6 (Broadcom and Oracle) to 5.1 (Tesla). Generally, investors consider a stock undervalued if its PEG is lower than 1.
Explanations for Nvidia’s low valuation vary. Goldman cites the disconnect between its earnings and stock price as an example of “the challenges of perceived ‘over-earnings.’”
“A dominant market position in the near-term can eventually give way to fears of over-earning, as competition increases and uncertainty about the sustainability of demand grows,” Goldman’s analysts wrote. As investors grow more nervous about an impending slowdown, they begin paying less for each dollar of profit, compressing the stock’s multiples.
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Morgan Stanley analysts on Thursday wrote the stock’s low multiple “does make sense, with close to $5 trillion in market cap, and limited operating margin leverage given very high profitability.” Effectively, Nvidia shares are running up against the Law of Large Numbers, the observation that growth becomes harder to sustain the larger a company gets.
Still, the pessimism hanging over Nvidia shares isn’t entirely rational, according to Morgan Stanley. “There appear to be generalist concerns that growth will slow, despite near term acceleration” and evidence that corporate, consumer, and sovereign AI use is on the rise, the analysts wrote.
Some experts are confident the market will come around on Nvidia stock this year. “At the end of the day, it is hard to see how the stock continues to languish,” wrote UBS’s Arcuri, who expects Nvidia’s earnings growth to accelerate in the second half while growth at recent AI darlings like memory and semicaps begins to decelerate.