Nvidia Q1: Sell The Irrational Exuberance
Contributor since 2023 / 512 Followers
Summary:
- Nvidia Corporation is one of the best publicly traded companies available.
- Despite the great business model and promising future prospects, valuation still matters.
- Irrational exuberance rears its head yet again, with Nvidia shares trading over 150x forward earnings.
Henrik Sorensen
Prelude
If I offered to sell you an asset that generated profits of $25.39b over the past five years, how much would you pay me for it? While deal-making, I mention to you that despite strong revenue growth, profit growth has been modest, but this asset is particularly well positioned in a booming industry and is set to compound for years. You’d certainly be interested, few wouldn’t be. We’re out to make money, after all. But how much would you pay to get a piece of the growth?
The value of a financial asset is the sum of all of its future cashflows discounted to today using some discount rate.
Let’s say this asset, which generated $4.37b in profit last year, costs about $750b. Would you pay that? You would need ~115% growth annually for the next 10 years for this investment to be worth its intrinsic value.
I understand the hype about AI. It’s a huge opportunity for everyone in the markets to find big winners. Nvidia Corporation (NASDAQ:NVDA) is certainly a benefactor of the Age of AI and will certainly grow revenue and earnings well into the future. However, a 115% annual rate for 10 years is an absolutely obscene expectation, even for Nvidia.
Earnings Review
The Good
Nvidia Corporation reported Q1 2024 results yesterday, beating expectation and raising guidance in spectacular fashion. The data center segment had a record quarter and is the root of the Nvidia hype. This segment has a roughly $1T current total addressable market, or TAM, which is almost certain to grow over time, and over which Nvidia has a near-monopoly position in advanced computing.
Jensen Huang, Nvidia CEO, continuously remarked in the Q1 earnings call Q&A session that the computer science field is undergoing a major transition toward accelerated computing. Nearly the entire $1T data center market is currently built on CPUs, which still serve their purpose well, but aren’t fit for the supercharged computing power that large language AI models (“LLMs”) demand. LLM’s are based on huge amounts of data computation in the form of matrix multiplication, which GPU’s are specialized for. Major customers in this market are cloud service providers (“CSPs”) who are willing to spend significant sums of money to accelerate their cloud capabilities.
The flagship product in Nvidia’s data center GPU value proposition is the H100, which is based on the new ‘Hopper’ architecture. These GPUs cost tens of thousands of dollars and Nvidia has significant pricing power in this market. Despite Advanced Micro Devices, Inc. (AMD) offering cost-efficient alternatives, Nvidia still has this market in a stranglehold. CSP’s can supercharge their AI applications by upgrading H100’s to use tensor cores, as well. Nvidia says this about tensor cores:
Since the introduction of Tensor Core technology, NVIDIA GPUs have increased their peak performance by 60X, fueling the democratization of computing for AI and HPC. The NVIDIA Hopper™ architecture advances fourth-generation Tensor Cores with the Transformer Engine using a new 8-bit floating point precision (FP8) to deliver 6X higher performance over FP16 for trillion-parameter model training. Combined with 3X more performance using TF32, FP64, FP16, and INT8 precisions, Hopper Tensor Cores deliver the highest speedups to all workloads.
Combining GPUs with Nvidia Omniverse, CUDA libraries, DGX cloud, and the coming Grace Hopper CPU, it’s clear that the Nvidia product ecosystem is amongst the best in the world. It’s extremely cost-efficient for CSP’s and other data center operators to depend entirely on the Nvidia hardware-software stack for all their computing needs (cloud and AI). With Nvidia, companies can easily train new AI models, continuously train existing models, and efficiently operate their data center despite exponential ramping of computation requirements.
The opportunity here is immense. Nvidia exhibited a classic “beat-and-raise” this quarter – blowing both current and future expectations out of the water. Management is now guiding for $11b Q2 2024 revenue against the $7.1b expected by Wall Street. Further, management is remaining cost-conscious with revenue growth outpacing OpEx and CapEx growth, which also led to a hefty increase in gross margin guidance of 68% (GAAP) and 70% (non-GAAP).
The Bad
Despite Nvidia Corporation beating estimates and raising guidance spectacularly, the $7.19b Q1 revenue represents a 13% YoY decrease. The recent few months of price movement has been rewarding for long-term shareholders. Courageous investors that bought the $112 dip in October of 2022 have been richly rewarded for the purchase. However, with annual net income totaling under $5b and staying mostly stagnant for the past five years, a valuation nearing $1T is abhorrent. Despite stagnant backward looking growth, the future certainly looks bright for Nvidia.
Gaming segment revenue was down 38% YoY while up 22% QoQ. Nvidia has a strong reputation for quality and innovation in gaming, but AMD is a legitimate contender which is likely to erode market share in the medium-to-long term. AMD gaming products are just more cost-efficient for most gamers than Nvidia’s. Across the price spectrum of gaming processors, AMD actually beats out Nvidia on specs for price. AMD products tend to offer similar processing power and more RAM for cheaper. Over time, AMD should eat market share from Nvidia. However, with Nvidia shifting focus and diving heavily into the data center market, the gaming segment may become the forgotten child of Nvidia over time.
The Ugly
Nvidia has an active stock buyback program totaling roughly $4B of stock. In the Q&A of the earnings call, an analyst asked about why there were no buybacks in Q1. Nvidia CFO Colette Kress fielded the question by noting that, yes, while there is an active buyback program, management seeks to repurchase stock opportunistically. Despite strong results, stronger guidance, and among the strongest future prospects, management did not consider Q1 of fiscal 2024 an opportunistic time to purchase Nvidia stock. Despite a glaringly obscene valuation and a reading on management’s behavior, Wall Street remains frenzied. Nvidia price targets were recently updated across a variety of Wall Street investment advisories and there’s only been upward revisions.
Not even Nvidia Corporation company management feels that this is an opportune time to purchase the stock. Although I believe Nvidia is a stock that everyone should want to own, there is a right and a wrong price for anything. Nearly $1T is the wrong price for Nvidia. Any long-term investor should not buy this stock with fantastic expectations for future returns.
Conclusion
Just as you shouldn’t try to catch a falling knife, you shouldn’t try to stop a rocket ship. While I strongly advise against buying puts or shorting Nvidia Corporation stock, I strongly advise that holders should take their profits. This is a generational opportunity for profit-taking, not a generational buying opportunity. Nvidia is priced for absolute perfection, and while management has delivered perfection to this point, there are clear macro concerns and geopolitical risks that make perfection nearly impossible.
There will be more entry opportunities in the future. There will be pullbacks that present an attractive risk-return profile. Right now is not one of those times. This is a stock currently trading at an insane multiple because of greed and “hopium.” For patient investors that wait for the right time to enter, Nvidia Corporation is a business that will continue to compound earnings over time and grow its intrinsic value. However, right now Nvidia Corporation stock is trading way too far above its intrinsic value for this to be an attractive opportunity.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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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