It's been a while, but it's happening to Nvidia (NVDA 1.61%) again.
A periodic oversupply of graphics cards has been a historical problem for the high-flying chipmaker, and the company's latest update indicates that the problem is back. Nvidia released preliminary results for the second quarter of fiscal 2023 (for the three months ended July 31, 2022), and it became clear that the chipmaker's days of terrific growth have been put on "pause."
Not surprisingly, Nvidia investors didn't react well to the news. The terrific rally in shares of Nvidia that began last month has suddenly lost momentum. It won't be surprising to see Nvidia stock head further south, at least in the near term. Here's why that may be the case.
Nvidia investors should brace for more pain
According to Nvidia's preliminary results, the company now expects fiscal second-quarter revenue of $6.7 billion compared to its earlier forecast of $8.10 billion. The latest forecast suggests that Nvidia's top line is on track to increase just 3% year over year, down significantly from its prior expectation of 24% growth.
The company blames the weakness in the gaming business for this poor showing. The company pointed out in a press release that it is witnessing lower sales in the gaming segment. Its channel partners have reduced purchases of graphics cards that power gaming PCs (personal computers), and Nvidia has also been forced to implement "pricing programs with channel partners to reflect challenging market conditions that are expected to persist into the third quarter."
More specifically, Nvidia's gaming segment revenue was down 33% year over year in the fiscal second quarter to $2.04 billion. However, the weakness in the gaming segment isn't surprising as there have been signs of weak graphics card demand of late. Nvidia itself had warned on its May earnings conference call that gaming revenue would take a $400 million hit on account of weak sales of gaming GPUs in Russia and China. But it now seems that the problem is bigger than Nvidia had anticipated.
High inflation is forcing Nvidia to reduce the price of its graphics cards and reduce inventory at the same time. In simpler words, Nvidia's gaming business is likely to be plagued by a combination of low volumes and weak pricing. That's bad news for the company as gaming is Nvidia's second-largest source of revenue, producing 43% of its top line in the fiscal first quarter. The segment's contribution has now dropped to 30%.
A turnaround in the video gaming segment looks unlikely as sales of PCs are dropping at an alarming pace. According to IDC, PC sales fell 15.3% year over year in the second quarter of 2022. The market research firm expects PC sales to drop 8.2% in 2022. At the same time, spending on video gaming hardware is also expected to decline. NPD estimates that video game hardware revenue could drop 8.7% in 2022 in the U.S.
All this doesn't bode well for Nvidia, which is the reason why analysts have reduced their growth estimates for the current fiscal year, reducing their revenue and earnings forecasts.
What should investors do?
Nvidia is an expensive tech stock that currently trades at 50 times earnings. That's way higher than the S&P 500's multiple of 22.5. A meaningful slowdown in Nvidia's growth means that investors may not be willing to pay such a rich multiple for the stock since it won't be able to justify the premium now.
As such, don't be surprised to see Nvidia stock head lower until and unless the situation in the PC and the gaming market improves. But then, savvy investors should consider keeping a close watch on Nvidia as the company has multiple catalysts that could help it come out of its slump.
From data centers to automotive to digital twins, Nvidia has several multibillion-dollar markets that it could tap into. Additionally, the gaming graphics card market is expected to clock annual growth of 14% through 2026, according to Mordor Intelligence. Considering Nvidia's strong grip over the gaming GPU market and the massive data center opportunity, the downturn is unlikely to last for a long time.
As such, investors looking to buy a top semiconductor stock for the long run should keep a tab on Nvidia and consider going long if it becomes too cheap to ignore following its glum near-term forecast.
