Shares of Nvidia (NVDA -1.11%) are down 33.8% year to date, compared to a 19.2% drop in the tech-heavy Nasdaq Composite index. Worries over macroeconomic headwinds such as inflation are weighing on the stock market right now, and one analyst also sees evidence that consumer demand for graphics processing units (GPUs) is slipping.
Baird analyst Tristan Gerra recently downgraded Nvidia over signs that selling prices for GPUs are starting to fall. Online retailer Newegg is currently showing discounted prices for Nvidia's more expensive GeForce RTX GPUs, and if these lower prices reflect lower demand, that could spell lower revenue for Nvidia's gaming segment, which provided nearly half of the company's sales in its fiscal 2022 (which ended in January).
Still, that lower stock price already factors in the possibility of lower growth. Plus, Nvidia estimates its long-term opportunity in gaming at $100 billion, or four times its annual revenue. So, should you buy the dip, or wait?
Weighing the pros and cons
Historically, demand for Nvidia's chips hasn't gone up in a straight line; it fluctuated depending on end-market demand. We saw this in 2018 when a pause in data center spending caused a decline in revenue for Nvidia's data center segment, which contributed to a sharp decline in the stock price.
Meanwhile, Nvidia's gaming revenue has grown at a compound annual rate of 25% over the last five years, thanks to an 11% annualized increase in unit sales and a 13% annualized increase in average selling prices. Because about half of its top-line growth came from its ability to raise product prices, Nvidia would be vulnerable if the supply-and-demand balance tips the other way and it has to reduce prices.
Chipmakers have been benefiting from a shortage of chips since the pandemic began. Gaming GPUs from Nvidia and Advanced Micro Devices have been relatively scarce at retail unless one was willing to pay nosebleed prices. The combination of supply shortages and high demand is great for manufacturers' bottom lines, but investors shouldn't expect Nvidia to continue doubling its profits year over year as it did in its fiscal fourth quarter.
On the flip side, if the supply shortages start to ease this year, that could still be good news for Nvidia. Selling prices for certain GPU models increased between 150% to 200% above normal levels. This kept many gamers from buying new GPUs last year. Assuming prices come back to normal, there should be plenty of pent-up demand. Nvidia estimates that only 30% of its installed base of users have upgraded to new GPUs that use the latest technology.
Moreover, Nvidia expects GPU selling prices to continue trending upward over the long term. An estimated 3.2 billion people globally now play video games. While only a fraction of them are PC gamers -- and thus Nvidia's target gaming business customers -- that massive number suggests there should be no shortage of demand for gaming GPUs over the long term.
Is the stock a buy?
Even after the pullback in Nvidia's stock, it still trades at an expensive price-to-earnings (P/E) ratio of 48, which is twice the P/E of the average stock in the S&P 500 index. Investors shouldn't buy these shares expecting a big return over the next year. It's impossible to know what waits around the corner for Nvidia. If the company experiences a disappointing quarter, the stock could plunge further. It looks particularly vulnerable to any potential bad news given that it still has a relatively high P/E.
However, if the stock falls much further, I would put my Warren Buffett hat on and consider scooping up a bargain. Nvidia has enormous opportunities across gaming, cloud computing, metaverse, and other advanced computing applications. This tech stock is not done hitting new highs over the long term.