Why I Still Wouldn’t Short Nvidia Stock

Summary:

• Nvidia Corporation reports its second quarter earnings on August 28.
• As usual, investors expect very high growth.
• Nvidia got caught up in a minor correction early in August, falling 20% from the June top to the August lows.
• Bearish takes on the stock have ramped up since it stumbled.
• In this article, I explain why now is not a good time to be shorting Nvidia.

NVIDIA Corporation (NASDAQ:NVDA) is scheduled to release its second quarter earnings on August 28. The release is expected to show very high growth in revenue as well as earnings. In the second quarter of last year, Nvidia did $13.5 billion in revenue and $0.18 in normalized EPS. This time around, it’s expected to do $28.54 billion in revenue and $0.64 in normalized EPS. The growth rates if Nvidia meets expectations will be 114% in revenue and 255% in earnings.

Despite, or perhaps because of, the high expectations, NVDA stock has been selling off in recent weeks. It hit a high of $124 back in June, and has fallen 20% in price since then. The stock got hit hard in last week’s market volatility, which saw many tech stocks and financials tumble to levels not seen since the start of the year. Reasons for the selloff weren’t clear at the time. It may have been a delayed reaction to big tech earnings, which were released just before the selloff began. Although most of the tech companies delivered high earnings growth, they guided for increased capital expenditure (“CAPEX”) in the coming quarters, which may have contributed to volatility in subsequent weeks as investors digested the implications of the increased spending.

It’s becoming common for analysts to expect skepticism about Nvidia’s current stock price. Bearish takes on the stock have grown in number on Seeking Alpha, with some recent “strong sell” ratings having been made. My current take on NVIDIA is similar to ones I posted in the past. I still think that investors shouldn’t hold it at greater than index weighting, unless they are willing to take on an above-average amount of risk.

However, with Nvidia having pulled back recently, I’m seeing less downside risk than I did before. NVDA stock has high multiples, but it also has high growth. Its free cash flow increased by an incredible 175% over the last 12 months, and by 83% per year over the last five years. Furthermore, there is evidence that all of this growth will continue for at least two more quarters. On their recent earnings calls, Google (GOOGL) and Meta Platforms (META) guided for increased AI CAPEX spending in the upcoming quarters. Meta in particular called for between $37 billion and $40 billion for the year, up from its previous range of $35 billion to $40 billion. Furthermore, in its most recent monthly revenue report, Taiwan Semiconductor Manufacturing aka TSMC (TSM) revealed that it grew sales by 45% in July. TSMC takes orders from Nvidia and others, but achieving its 45% growth spurt right while Meta and Google guided for increased CAPEX spend tends to suggest that TSMC’s orders are increasing largely because of demand for AI server infrastructure. If that’s the case, then Nvidia was probably behind TSMC’s July revenue surge and most likely saw its revenue surge in the same period.

When tech stocks were trending downward last week, I thought it peculiar that Nvidia and TSMC were crashing along with the software companies. As the world’s main supplier of AI accelerator chips, Nvidia makes money off the AI server spend that META, Google, and others are undertaking. Things which threaten those companies’ margins actually line Nvidia’s pockets. Meta is spending billions of dollars per year on Nvidia GPUs, and there is no sign of the pace of spending slowing down in the coming quarters. In fact, the company’s guidance for $37 to $40 billion in CAPEX spend for the year implies higher spend in the coming quarters, as its first and second quarter spending amounts were not even half of $37 billion. So, spending on Nvidia chips is likely to continue for the foreseeable future.

When I last wrote about Nvidia, I rated it a “hold” because it had both high growth and a steep valuation, making it difficult to value. I still take a neutral view on the stock; however, with the recent pullback, I now think that those shorting the stock are taking a bigger risk than those going long. While I’m staying away from the stock personally, I think that shorting it would be an even worse idea than going long. In the ensuing paragraphs, I’ll explain why I feel that way.

Competitive Landscape

One reason why Nvidia may surprise to the upside in its coming earnings release–and for some time thereafter–is because it has a dominant position in a growing market. CNBC has estimated Nvidia’s market share as between 70% and 95% in AI chips. It’s difficult to come up with a precise estimate because the share varies depending on which types of AI chips you’re talking about. There are many companies developing on-device AI chips, such as Qualcomm (QCOM) and Apple (AAPL). However, the majority of AI data center chips are being sold by Nvidia. Advanced Micro Devices’ (AMD) MI300 series chips compete with Nvidia’s chips, but the latter’s offerings remain strongly preferred by big tech companies. As of February, Nvidia had a 98% market share in AI data center GPUs.

If Nvidia GPUs can remain big tech’s AI accelerator chips of choice, then the company will enjoy a lot of revenue and considerable pricing power going forward. Given META and GOOGL’s guidance, and TSMC’s July sales spike, we’d expect this market dominance to continue until at least the end of this year.

However, cracks are beginning to show in Nvidia’s moat. When Apple announced Apple Intelligence, it said that its new AI products would be processed mainly on-device, using its own chips. Around the same time, Google announced its AI processing unit called Trillium, whose performance per unit of power was improved 4.7X from the company’s previous generation chip. Because of these and other developments, Peter Thiel said that he didn’t think that Nvidia’s monopoly “was all that durable.”

So we’ve got Nvidia with a near-monopoly market share, but with many competitors trying to catch up with it. It’s likely the company will keep delivering high growth and fat margins for the remainder of the year, but then again, with the stock at 58 times earnings, a lot of growth is already being paid for. There is no obvious move either long or short here, which is why I think that Nvidia is best avoided at these levels.

Valuation

One reason why shorting Nvidia today might not work is because the stock’s valuation is not as steep as it seems. This is a conclusion I arrived at after considerable debate. Although Nvidia’s multiples are high, the company also enjoys near-monopoly status in the world’s hottest industry. If the competition doesn’t heat up soon, then the growth will only continue. AI has not reached anywhere near the GDP impact that experts think it will ultimately have. PwC estimates that AI will result in GDP being $15.7 trillion higher than it otherwise would have been by 2030. Last year, the entire generative AI industry was worth $515 billion. If PwC’s forecast is correct, then AI still has a lot of growing to do.

We need to keep this in mind when looking at Nvidia’s valuation multiples. At today’s prices, Nvidia trades at:

• 58 times adjusted earnings.

• 61 times GAAP earnings.

• 32 times sales.

• 52 times book value.

• 63 times cash flow.

These seem like high multiples, but remember that AI is currently only 3.3% of what PwC thinks it will eventually become. If AI investment continues growing to reach the level it’s expected to reach, then demand for AI accelerator chips will continue to be high, and Nvidia sells 94% of the AI accelerator chips used in data centers. There is therefore considerable potential for Nvidia’s growth to continue. And that growth is very high: the company compounded its free cash flow at 83% per year over the last five years!

At the same time, this all depends on Nvidia’s moat remaining intact, and I can’t say for sure that it will. No doubt, AMD, and others are investing large sums of money into developing AI chips that can compete with Nvidia’s. Apple reportedly trained its AI models on Google’s chips rather than Nvidia’s GPUs, and Apple is a company with more than enough money to invest in top of the line Nvidia chips if it’d like to. Cracks in Nvidia’s moat are starting to show, which is why I, personally, will not be paying 58 times earnings for Nvidia shares. Still, all signs from Nvidia’s buyers (Google, Meta) and suppliers (TSMC) indicate that the party will continue until at least the end of this year. So those going short NVDA could end up experiencing substantial losses.

The Bottom Line

When a stock is in the news constantly, it’s always tempting to bet on it, whether you agree with the hype or not. The ubiquity of the stock makes an investment in it–long or short–seem inevitable. But it isn’t. Often, battleground stocks are battlegrounds for a reason. The bullish and bearish theses both have merit. In situations like these, it’s better to simply avoid a stock and look elsewhere. That’s how I plan to approach Nvidia for the foreseeable future.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of TSM, GOOG 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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