NVIDIA (NVDA 6.18%) stock has regained its mojo of late, gaining nearly 50% in the past six months thanks to a turnaround in its gaming and data center businesses. The graphics specialist gets nearly 80% of its revenue from the two segments, so improving business prospects in these businesses have encouraged investors to buy more shares.
But the problem is that NVIDIA's recent rally has made the stock expensive. The stock is now trading at a rich price-to-earnings (P/E) multiple of 63. This is much higher than the stock's five-year average P/E ratio of 38.
NVDA Revenue (TTM) data by YCharts
At the same time, the company's recent quarterly results have not been up to the mark. Its top and bottom lines shrank last quarter and the outlook was lighter than anticipated, making NVIDIA stock overvalued at current levels. So, does this mean that investors shouldn't buy NVIDIA stock anymore? Let's find out.
Taking a deeper look at NVIDIA's performance
Though NVIDIA's top and bottom lines have been heading south over the past few quarters, things are about to change for the better. The company's outlook for the current quarter might have been lighter than expectations, but it would mark a return to growth.
NVIDIA expects $2.95 billion in revenue in the fourth quarter of fiscal 2020, which would be a 34% improvement over the prior-year period's top line of $2.2 billion. The chipmaker credits this impressive top-line growth to strong demand in its gaming and data center businesses. Both these segments delivered impressive sequential growth last quarter, and they look good for more thanks to NVIDIA's product-development moves and the end-market opportunities.
The gaming business, for instance, is witnessing a nice turnaround. NVIDIA gained five percentage points of market share on a sequential basis in the third quarter of 2019 in the discrete GPU (graphics processing unit) market, according to Jon Peddie Research.
Image source: Getty Images.
The impressive thing to note here is that NVIDIA's market share increased despite the launch of new graphics cards by archrival Advanced Micro Devices. NVIDIA held nearly 73% of the discrete graphics card market at the end of the third quarter, and it could continue to dominate this space thanks to its next-gen cards.
Taipei Times reported last month that NVIDIA's next-generation GPUs based on the 7-nanometer (nm) manufacturing process could deliver a 50% jump in graphics performance while reducing power consumption by half. Such a product line could put NVIDIA in a great position to take advantage of the fast-growing gaming laptop market.
Gaming laptops are generally more power-hungry when compared to regular computers, as they require more computing power to run games, which takes a toll on battery life. If NVIDIA comes out with graphics cards that are capable of reducing power consumption and boosting computing power simultaneously, it could become the go-to supplier for gaming laptop OEMs (original equipment manufacturers).
Third-party research predicts that the gaming laptop market could clock an annual growth rate of 22% through 2023. The good part is that NVIDIA is already making waves in this market. Gaming laptops were a crucial growth driver for NVIDIA in the third quarter, with the company's partners launching over 130 such models.
So it won't be surprising to see gaming laptops push NVIDIA's gaming business higher this year.
NVIDIA's data center growth could take off
NVIDIA's data center business hit a purple patch last quarter thanks to the increasing demand for artificial intelligence (AI) applications in the cloud. Its data center revenue increased by almost 11% sequentially, and more improvements could be in the cards for a couple of reasons.
First, the hyperscale data center market is expected to clock an attractive compound annual growth rate of 24% through 2024 as per third-party estimates. NVIDIA is already benefiting from this fast growth, as shipments of its Tesla GPUs (which are used in data centers) hit a record in the third quarter.
The second reason why NVIDIA's data center revenue could keep growing is that the company is now reportedly taking steps to consolidate its place in the hyperscale data center market. The Next Platform reports that a supercomputer at Indiana University fitted with the next generation of Tesla GPUs is expected to deliver a 70% to 75% improvement in performance.
This is a positive sign of things to come, as more powerful data center GPUs from NVIDIA should help it stay ahead of the curve in the industry and pave the way for long-term growth.
NVIDIA's valuation should not be an issue
Given that NVIDIA's two major businesses appear to have bright prospects, the stock's current valuation shouldn't be in the way for anyone looking to buy the stock. We have already seen that NVIDIA is expected to deliver impressive revenue growth this quarter, and the more important thing is that the chipmaker is expected to sustain that momentum.
The company's revenue in the current fiscal year (which has just begun) is expected to jump over 19%, according to analyst estimates compiled by Yahoo! Finance. The company's earnings are expected to jump from $5.57 per share in the recently concluded fiscal year to $7.26 per share in the current one. This is why the stock's forward P/E ratio of 33 looks more reasonable, and investors looking for a potential growth stock should keep NVIDIA on their radar.
