NVIDIA (NASDAQ:NVDA) stock has gone ballistic. It's returned 634% over the two-year period through June 16, versus the S&P 500's 22% return.
Investors have poured money into the graphics-chip maker's stock on account of its recent strong financial performance, and they hope the financial good times will continue. But the soaring stock price and ballooning valuation beg the question: How risky is NVIDIA stock now?
Let's explore the three types of risk all companies face: internal, external, and financial.
Internal risks relate to things within a company's control, such as setting a strategy, executing on that strategy, and successfully innovating. Internal risks largely stem from not having the right top management team.
This risk is well controlled, as NVIDIA has a strong CEO: Jen-Hsun Huang is a co-founder of the company and knows it intimately; has a hefty financial stake in the company; and gets top ratings on Glassdoor. Huang is 54 years old, so investors can probably count on him leading the company for a while longer.
External risks are those risks that are outside of a company's control, and include such things as increased competition and changing demand for its products and/or services due to factors beyond its control. NVIDIA's two main external risks, in my opinion, are:
- Increased competition from Advanced Micro Devices (AMD) within gaming, its largest market platform, which accounted for 58.8% of its revenue in fiscal 2017;
- Other technological approaches to artificial intelligence (AI) becoming more favored than its graphics processing unit-based deep-learning approach to AI. Potential competitors are numerous, and include Alphabet's Google and Apple.
NVIDIA is currently sitting pretty in the high-end PC gaming market, commanding 72.5% market share in discrete GPUs for desktops compared with AMD's 27.5% share in the first quarter of 2017, according to Jon Peddie Research. The launch of its Pascal GPU architecture last May has been powering its gaming results, as gamers have been enthusiastically upgrading their graphics cards.
In late July, AMD is slated to launch its graphics card for consumers based on its much-touted new Vega architecture. Only time will tell how successful it will be in its attempt to take share from NVIDIA. In my view, winners often keep winning, so it seems more likely than not that NVIDIA will be able to maintain its dominance over AMD.
There are too many potential competitors in NVIDIA's rapidly growing, artificial intelligence-driven businesses -- data center and self-driving vehicle technology within its auto platform -- to explore here. AI is in the early innings, with numerous companies wanting a piece of the action. Some companies investors should keep an eye on are Google, Apple, and Intel, which is buying driverless vehicle tech company Mobileye. Last month, Google announced the second generation of its Tensor Processing Unit (TPU) chip, designed to run its deep-learning algorithms. In addition to Google using these chips for internal purposes, they'll be available for others to use via Google Cloud, just as NVIDIA's GPUs are. And last week, Apple CEO Tim Cook finally confirmed that the tech giant is working on driverless car technology, calling it the "mother of all AI projects."
NVIDIA's data center platform has been particularly benefiting from the market's embrace of the company's GPU-based deep-learning approach to AI. The company's Tesla-based GPU accelerators are now used by all of the world's major internet and cloud service providers, including Amazon's AWS, Facebook, Google, IBM, Microsoft, Alibaba, Baidu, and Tencent. In the last year, the company's auto platform has also begun to benefit from the race toward fully autonomous cars. Numerous top automakers, suppliers, and others are developing their autonomous driving systems using NVIDIA's DRIVE PX 2 AI car platform.
NVIDIA, like all public companies, has financial risks related to its business and its stock. Business financial risk stems from a company not having enough financial resources to grow, or sometimes even just maintain, its business. A company's stock-related risk stems largely from its stock's valuation.
NVIDIA's in good shape on the business risk front. It had $6.21 billion in cash and cash equivalents on its balance sheet at the end of the most recently reported quarter, Q1 of fiscal 2018, and long-term debt of $2.29 billion. It's in considerably better shape than AMD, which had $943 million in cash and equivalents and carried $1.41 billion in debt at the end of its most recently reported quarter. NVIDIA naturally doesn't have the resources that Google and Apple do.
Turning to stock-price risk, here are NVIDIA stock's valuations using some common metrics: the price-to-earnings (PE), price-to-free-cash flow (P/FCF), and forward P/E ratios.
These are high valuations, though looking at valuations in a vacuum has little value. Investors should consider projected earnings growth rates.
The consensus among Wall Street analysts is that NVIDIA will grow earnings per share 20.2% this fiscal year, 12.9% in fiscal 2019, and at an average annual rate of 12.2% over the next five years. NVIDIA stock appears quite overvalued if you believe that it will only grow EPS at an average rate of 12.2% over the long term. However, there's good reason to believe that analysts are underestimating NVIDIA. They've routinely done so for some time -- and considerably so. In the last four quarters, for instance, NVIDIA has beat EPS estimates by 8.1%, 45.6%, 19.3%, and 19.7% -- that's an average of 23.2%.
In short, NVIDIA stock seems moderately risky. The primary external risk investors should monitor is competition within the company's AI-driven businesses, as one or more of the tech heavyweights could prove to be formidable competitors. The stock is pricey on an absolute basis, but is arguably worth paying up for if you believe that NVIDIA's GPU-based deep-learning approach to AI will continue to be embraced and will emerge a winning AI tech over the long run.