Nvidia: The Correction Was Justified and Valuation May Still Be High


Nvidia (NVDA) operates as a visual computing company that engages in the design and manufacture of computer graphic processors, chipsets and related multimedia software.  As a result, the company is involved in many exciting technologies that are either already mainstream popular and technologies that offer enticing future growth prospects such as self-driving automotive technology.  The following short business description courtesy of S&P Capital IQ elaborates on their businesses:

“NVIDIA Corporation operates as a visual computing company worldwide. It operates through two segments, GPU and Tegra Processor. The GPU segment offers processors, which include GeForce for PC gaming and mainstream PCs; GeForce NOW for cloud-based game-streaming service; Quadro for design professionals working in computer-aided design, video editing, special effects, and other creative applications; Tesla for AI utilizing deep learning, accelerated computing, and general purpose computing; GRID provides power of NVIDIA graphics through the cloud and datacenters; DGX for AI scientists, researchers, and developers; and cryptocurrency-specific graphics processing units.

The Tegra Processor segment provides processors designed to enable branded platforms – DRIVE and SHIELD; DRIVE automotive computers and software stacks, which offer self-driving capabilities; SHIELD devices and services designed for mobile-cloud in home entertainment, AI, and gaming applications; and Jetson TX 2, an AI computing platform for embedded use. The company’s products are used in gaming, professional visualization, datacenter, and automotive markets.

NVIDIA Corporation sells its products to original equipment manufacturers, original device manufacturers, system builders, add-in board manufacturers, retailers/distributors, Internet and cloud service providers, automotive manufacturers and tier-1 automotive suppliers, mapping companies, start-ups, and other ecosystem participants. The company has a strategic partnership with XPENG Motors to develop Level 3 autonomous driving technology for the driving environment in China. NVIDIA Corporation was founded in 1993 and is headquartered in Santa Clara, California.”

Nvidia: An Important Lesson on The Principles Of Valuation

Since the beginning of fiscal year 2014, which starts in January, Nvidia has produced an exceptional record of earnings growth averaging just under 49% per annum.  Over that time, Nvidia investors have enjoyed significant capital appreciation because of strong earnings growth coupled with P/E expansion rising from 15 to over 43 times adjusted earnings.  Consequently, shareholders received more than an 18 fold increase in the value of their shares from the low price of $15.70 at the beginning of fiscal 2014 to the stock price peeking in September 2018 at $285 per share.  This included a modest amount of dividends of approximately $1400, which translated into a total annualized rate of return of 86% per annum.

Just so you’re clear, a one-time $10,000 investment on January 31, 2014 would be worth $180,388 by September 28, 2018.  However, since the end of September 2018 the stock price has subsequently fallen approximately 43% to its current value of approximately $160 per share.  Nevertheless, that initial $10,000 investment would still be worth $103,415 as of yesterday’s close.  On the other hand, losing $77,000 in two short months is not fun.

All this growth and price volatility has generated a lot of buzz and variant opinions as to whether Nvidia is now a buy or not.  Therefore, I thought it would be interesting to evaluate Nvidia fundamentally by the numbers over this timeframe to try to bring some clarity to the past, present and current valuation of this interesting and fast-growing semiconductor company.  From my perspective, everything that has happened to Nvidia’s stock price since the beginning of 2014 is fundamentally justified.  This is precisely why I consider this company and its recent history as a quintessential example of important lessons in valuation.

To be clear, Nvidia’s valuation was initially justified based on its operating growth over the timeframe January 2014 to September 2018.  Furthermore, the precipitous drop in stock price since September 2018 was also justified based on the company’s operating growth steadily slowing in fiscal 2018 and thus far in fiscal 2019 which ends in January, 2019.  Finally, depending on which metric you choose to value Nvidia on, the company currently appears reasonably valued to moderately overvalued.

The critical lesson about valuation with this example is that intrinsic value is a dynamic concept that is significantly influenced by a company’s evolving operating growth.  Stated from another perspective, past valuations versus current valuations versus future valuations are dynamic and ever-changing.  Consequently, it is critical that investors consider all aspects of the company’s operating results when monitoring its valuation.  Furthermore, at the end of the day, buy sell or hold decisions are best made based on future expectations.  However, there is a conundrum attached to this perspective.  Past operating results are actual and factually measurable as a result.  In contrast, future operating results are always uncertain and based on expectations that have not yet occurred.  Nevertheless, it has long been my contention that forecasting future earnings and/or cash flow growth is the key to successful common stock investing.

FAST Graphs Analyze Out Loud Video: Nvidia’s Valuation By the Numbers Past, Present and Future

I believe it’s critically important that investors recognize and accept the reality that fair valuation is a dynamic concept.  Equally as important, is the fact that valuation is also a relative concept which cannot be calculated in a vacuum.  Fair value or intrinsic value can only be calculated as it relates to important financial characteristics.  One of the most important is the growth rate of the earnings or cash flow metrics that are being examined and/or evaluated.  Moreover, the future growth rate is significantly more relevant than historical achievements.  Simply stated, you can learn from the past, but you can only invest in the future.

To be clear, what I’m suggesting is that you cannot make valuation decisions based solely on multiples of earnings (P/E ratios), multiples of cash flow (P/CFL) or any other commonly used valuation metric.  These metrics must be evaluated in the context of the company’s potential future growth of those earnings or cash flows.  From this perspective, I am discussing the most commonly accepted valuation practice of calculating valuation based on discounting future cash flows (earnings) back to the present value.

The following FAST Graph analyze out loud video on Nvidia will serve as a quintessential example that clearly illustrates the valuation principles that I am discussing in this writing.  In the video you will see that Nvidia was reasonably valued from early 1998 through early 2008 when its P/E ratio ranged between 29 to 36, because its operating earnings growth was averaging 29 to 30% over that time frame.

Additionally, the video will illustrate that Nvidia was fairly valued with a P/E ratio of 15 from early 2009 to early 2016 when earnings growth was only averaging 3%.  Furthermore, the video will clearly show that Nvidia was fairly valued from January 2016 through September 2018 when its P/E ratio hovered between 34 and 45.

Finally, the video will further illustrate that despite its recent precipitous drop in value that the company remains overvalued based on reasonable expectations of future growth.  Watch the video and you will discover that valuation is truly a dynamic and a relative concept.


Summary and Conclusions

Whenever you are trying to determine if a company is fairly valued or not, you need to consider both its dynamic nature and the relevance of its growth past, present and future.  By examining the past, you can gain insight into how and why a company was valued like it was by the market.  Additionally, you can learn a lot about what kind of company from an operating perspective you are looking at.  Is it a consistent grower, is it cyclical, is it a fast grower or a slow grower?  Therefore, you can apply this understanding towards making a rational assessment of what you might be able to expect the company to look like or do in the future.  But in the final analysis, nothing replaces comprehensive research and due diligence.

In the context of Nvidia, I consider the company moderately overvalued based on future expectations.  The recent precipitous drop in stock price I also consider justified on two counts. First and foremost, I believe that Nvidia’s valuation in 2016, 2017 and for the most part of 2018 was justified based on extraordinary growth.  However, if that extraordinary growth has truly passed as analysts currently expect, then I also feel that the precipitous drop in price was justified based on those future expectations.  Finally, Nvidia has been a terrific long-term holding.  However, future growth although expected to continue at above-average rates would not justify current valuations.  Therefore, I would look for a better entry point before investing, but I would also understand that that might not happen – at least in the short run.

Disclosure:  No position.

Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.