Nvidia (NVDA 0.14%) has its fingers in numerous pies and is rapidly growing in each. The graphics chip specialist has the potential to be a leader in many, if not most, of the new categories, and its just-reported third-quarter earnings report shows it's well on the way.
The bullish case rests upon Nvidia maximizing that potential, while the bear case says that for all that the semiconductor stock is growing, the market has already baked the opportunities into the stock price and then some.
This stock is overdue for a massive correction
Anders Bylund (Nvidia bear): It's hard to argue with Nvidia's results. The company has delivered an average top-line growth of 20% per year over the last three years, and earnings jumped 12% per year over the same period. The growth rates are even accelerating lately, as Nvidia's year-over-year revenue growth spiked to 68% in the second quarter of fiscal 2022, a period that ended on Aug. 1. The company delivers solid growth across several key markets, including data center processors and gaming chips.
Strong demand from these key sectors is driving street-level prices for Nvidia's cards way up, and that effect is amplified by the surging cryptocurrency market. The company is taking steps to limit crypto-mining demand for gaming cards, limiting the hash rates its latest cards can produce for mining Ethereum tokens and releasing a crypto-specific version that lacks video output ports and wouldn't help a gamer at all.
That's a lot of good news, but all of it has already been priced into Nvidia's surging stock prices.
Nvidia shares have gained 125% over the last year, including a 113% surge in the last six months alone. At these prices, the stock trades for princely valuation ratios such as 109 times trailing earnings, 121 times free cash flows, and 35 times sales.
A lot of things will have to work out for Nvidia in order to earn these lofty valuations. The company better have its ducks in a row for the next generational upgrade of its graphics processor technology. A small hiccup here could decimate the stock price.
And what if the cryptocurrency boom cools down again? Nvidia's management takes great pains during their earnings calls to make the crypto mining aspect sound nearly irrelevant to the company's financial results. I'm not convinced. If Ethereum jumps off a cliff again, as it did after a massive price surge in 2017, I expect to see graphics card demand plunging and street prices cooling down, with disastrous results for Nvidia's reported results.
I can't say for sure that there's a crypto crash around the corner, nor that Nvidia will fail to execute on its next several product launches. But the risks are real and the potential downside from this lofty perk is huge.
With a market cap of $760 billion, Nvidia is priced for absolute perfection. Come back and see me if and when the stock goes through a painful correction that drives share prices at least 30% lower. The inflated prices we see today are just too rich for my blood.
A stock worth every penny
Rich Duprey (Nvidia bull): There's no stock better associated with graphics cards for gaming than Nvidia, as its graphics processing units (GPUs) have made immersive, processing-intensive video games possible.
With increased adoption of cloud-based gaming, Nvidia is also seeing growth with its GeForce Now cloud gaming service. It uses deep learning super sampling (DLSS) technology it developed to greatly enhance the gaming experience by taking low-resolution images and scaling them up to high resolutions for display on high-res screens through the application of artificial intelligence.
Even so, while gaming generated 45% of third-quarter total revenue, it is using the experience and expertise gained in that field to expand into new markets using artificial intelligence to enter data centers, automotive, healthcare, and networking. Those markets now account for more than half of Nvidia's revenues and are hitting record levels.
Data centers alone equal almost as much as gaming and should grow to become Nvidia's largest segment by 2025.
Cryptocurrencies and mining are new spaces that hold considerable potential for Nvidia because of the strength and speed of its processors. Its Nvidia CMP HX, a dedicated GPU for professional cryptocurrency mining applications, was designed specifically to optimize mining operations by taking advantage of its superior processing capabilities.
I do agree with Anders about crypto being a potential stumbling block should mining collapse, but that is more of a concern for future performance. Revenue dedicated to that activity was only $105 million in the quarter, so any effect, even if there are residual side effects, will be minimal. There are much more meaningful drivers at the moment, including cybersecurity, 5G networks, and robotics.
In cybersecurity, for example, Nvidia is using its AI-driven Morpheus technology as the foundation for its zero-trust security platform. BlueField fully protects data centers by requiring all users to be authenticated, authorized, and validated before gaining access to applications and data. It works locally, in the cloud, or in hybrid situations.
Analysts are forecasting Nvidia will grow revenue from $16.5 billion in 2021 to $53 billion in 2026, a better than 26% compound annual growth rate. They've also increased how fast they expect earnings to grow, surging more than 36% annually, to $10.37 per share.
Anders is also right that Nvidia stock isn't cheap, trading at 67 times next year's earnings and over 100 times the free cash flow it produces. Although its earnings report didn't indicate it, hiccups like the computer chip shortage are also a threat that could undermine its premium valuation. Yet as an industry leader still growing at a rapidly expanding rate, I think Nvidia can easily support its premium price tag.