Nvidia: ‘Supercycle’ Era Awaits, I’m Not Running This Time (Rating Upgrade)

Summary:

• My previous Sell thesis on Nvidia Corporation stock has not panned out. While I kept most of my exposure, I’m starting to think I sold too early.
• Nvidia looks well-primed for further market share gains through its AI chips leadership. I explain why, this time, it’s seemingly different from its consumer GPUs over the past two years.
• While Nvidia remains overvalued, its competent execution is likely keeping investors on board, with buyers willing to buy the dips in support.
• I make the case why Nvidia investors need to change tack. Instead of considering when to cut exposure, they should consider when buying more shares is appropriate.
• I upgrade my rating as we head into Nvidia’s second-quarter earnings release. Let me know if you think my upgrade is timely.

Since my previous caution to investors of Nvidia Corporation (NASDAQ:NVDA) in May, the stock has consolidated but didn’t underperform the S&P 500 (SP500), despite topping out in mid-July.

I’ve revisited my Sell rating (bearish/market underperform) and assessed that NVDA sellers didn’t demonstrate sufficient momentum in forcing a steeper selloff. The AI chips-driven cycle appears to have helped increase investors’ confidence that Nvidia is at the earlier stages of a “supercycle,” bolstered by further market share gains of AI chips in the data center construct.

Therefore, analysts’ estimates and price targets or PTs have risen significantly, even though my assessment suggests that NVDA remains overvalued. Despite that, my price action instincts necessitated me to study NVDA’s buying sentiments/buying psychology to understand whether a sell signal still makes sense.

Before I go into that, I believe investors must assess whether we need to be concerned about the expected normalization in demand/supply dynamics in AI chips moving forward. Notably, we saw how Nvidia’s consumer GPU tight supply dynamics unfolded rapidly over the past year as macroeconomic conditions weakened. Hobbled by pulled-forward consumer spending, Nvidia suffered a significant pullback in downstream revenue (plus oversupplied inventory), leading to a battering in NVDA.

However, that battering has been fully recovered and more, with NVDA remaining well above its November 2021 highs. Therefore, investors must try and understand whether a repeat of the previous hammering could happen as downstream server ODMs raise their production capacities to cater to a surge in AI server demand.

I believe there’s a critical difference here. Nvidia is the market share leader in downstream consumer GPUs. A significant normalization in the market dynamics is expected to hit it hard. On the other hand, Nvidia’s AI chips have just started to penetrate server spending, with the x86 CPUs of Intel (INTC) and AMD (AMD) still leading the market.

As such, I believe that could explain why analysts’ estimates on Nvidia have risen significantly over the next two to three years, seeing further market share gains in Nvidia’s AI chips in the data center construct. In other words, it’s reasonable to assume that Nvidia’s current AI chips upcycle has much more momentum than I previously thought was possible.

Does it make sense? Let’s take a look. Analysts’ estimates suggest that Nvidia could deliver a significant growth inflection in its upcoming second quarter or Q2FY2024 earnings release. Accordingly, Nvidia is estimated to post revenue of $11.07B (up 65% YoY), above the company’s previous guidance of $11B. Nvidia’s adjusted EBIT is expected to reach $5.89B with a margin of 53.2%.

Furthermore, analysts’ estimates see sustained operating leverage gains through FY26 (year ending January 2026). Nvidia’s adjusted EBITDA is estimated to increase at a 3Y CAGR of 79% from FY23-26. Hence, I believe it should explain why buyers have remained confident about not selling en masse (as seen in late 2021). Moreover, Nvidia’s excellent execution as the AI chips leader has likely bolstered investors’ confidence in further market share gains. Intel and Advanced Micro Devices have yet to deliver their AI chips in significant volume.

NVDA last traded at a forward EBITDA multiple of 52.2x, well above its 10Y average of 30.1x. If we look further out, NVDA’s FY26 EBITDA multiple of 32.4x suggests the market has likely reflected “flawless execution” over the next few years.

As such, buyers are likely betting that CEO Jensen Huang and his team have the execution prowess to outperform Wall Street estimates, given its market leadership. Therefore, even if buyers were to trim their exposure, they likely don’t see a need to sell rapidly, encouraging dip buyers to take advantage of downside volatility to add more exposure.

My analysis suggests that NVDA has been consolidating rather than getting sold off intensely over the past six to eight weeks. That indicates that I’m increasingly confident that investors should look for opportunities to buy significant dips than consider when’s the next opportunity to cut considerable exposure.

As such, I’m raising my rating on NVDA in anticipation of continued robust execution from Huang & team moving ahead. I will likely join the buyers at steep selloffs to reinstate my previous exposure in NVDA as I took some profits.

Rating: Upgrade to Hold (On the watch for a rating change). Please note that a Hold rating is equivalent to a Neutral or Market Perform rating.

Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of NVDA, AMD, INTC either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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