Nvidia (NVDA 0.95%) It is one of the best stocks to hold in the past few years. Not only is it up nearly 200% this year, but it’s also been a huge long-term performer in the market. Since 2020, Nvidia is up more than 600%, turning every $1,000 invested into more than $7,000. For a company of Nvidia’s size, those returns have been explosive.
But are these gains sustainable? What expectations do current and future shareholders have for the future? Let’s take a look.
GPU can be used for many tasks
Nvidia’s business is focused on one key piece of computing hardware: the graphics processing unit (GPU). Led by current CEO and founder Jensen Huang, Nvidia invented the GPU in 1999, enabling real-time programmable shading of game graphics.
The biggest leap forward, however, is parallel computing, which is how GPUs operate. This makes GPUs ideal for any compute-intensive application. As a result, GPUs can now be used for any computationally intensive process, such as engineering simulations, cryptocurrency mining, or training artificial intelligence (AI) models.
The latter use case has recently provided a boost to Nvidia’s stock price, which has soared since the company issued guidance that revenue would rise 64% in the second quarter of fiscal 2024 due to higher demand for artificial intelligence chips. Nearly 40%. But Nvidia’s performance has come at a high price, as the company may have outpaced its business performance.
Nvidia Stock Is Very Expensive
Since Nvidia is a tech hardware company, it can be subject to ups and downs in the demand cycle. The most recent drop came when the cryptocurrency market crashed last summer, destroying demand for Nvidia’s gaming chips (the variety used to mine cryptocurrencies). The segment’s revenue fell 38% year-over-year, but rose 22% quarter-on-quarter, showing some recovery.
But Nvidia’s profit margins have taken a hit over the past year as demand has evaporated and Nvidia’s workforce has been overwhelmed.
NVDA Profit Margin (Quarterly) Data by YCharts
However, Nvidia has resized some divisions and combined with new demand, its margins improved significantly after a few poor quarters. Therefore, using a trailing price-to-earnings (P/E) ratio to value the stock is useless because it includes periods when Nvidia is not optimizing for profits. Otherwise, investors are left with a P/E ratio of 221, which is too expensive for almost any stock.
Instead, you can use the price-to-sales ratio or forward price-to-earnings ratio (using analyst forecasts) to get an idea of how Nvidia is currently trading relative to historical points. Nvidia remains an extremely expensive stock from a price-to-earnings ratio perspective.
NVDA PS ratio data provided by YCharts
Even when you look at its forward price-to-earnings ratio, the stock is trading well above its normal valuation range. Also, very few stocks can sustain a P/E ratio of 40 because they either grow revenue to lower valuations, or their share prices plummet to reduce the numerator portion of the ratio.
The forward P/E ratio tells a similar story, as 54 times earnings isn’t a cheap price tag either.
NVDA P/E Ratio (Forward) Data by YCharts
With Nvidia’s forward trading levels considered expensive for tracking levels, the stock is perfectly priced. Nvidia will have to deliver a stellar quarter in the second quarter to maintain its super-heavy price tag. Even if the company reports another quarter of blowout earnings, the stock likely won’t see much volatility, as perfection is expected at this price.
So what should shareholders do? Building the best AI models and powering data centers requires best-in-class products from Nvidia. This will always keep demand for Nvidia products high, but the company has shown how it can get caught in a hype cycle (like cryptocurrencies) and struggle for years.
Because of this, I think investors would be wise to take profits here, as there isn’t much upside. However, selling that position outright might not be the best move either, as Nvidia could surprise us all with a higher Q3 guidance (just like it did for Q2).
Nvidia is a leading company, but its stock is so expensive that it’s hard to do a reasonable analysis.