What happened
Federal Reserve Chairman Jerome Powell warned today that he plans to keep monetary policy tight "for some time," even if it inflicts "some pain" on American businesses and consumers. And it seems that was enough to spook growth stock investors on Friday, with semiconductor stocks featuring heavily among the decliners.
At 2:20 p.m. ET on Friday, shares of Nvidia (NVDA +0.64%) reversed course sharply from their surprise rise post-earnings Thursday, and are now down 8.1%. Following in Nvidia's footsteps are shares of its archrival chipmaker Advanced Micro Devices (AMD +0.84%) down 5.2%, and Applied Materials (AMAT +1.50%), a manufacturer of equipment for making semiconductor chips, down 4.9%.
NASDAQ: NVDA
Key Data Points
So what
The Fed chair's comments today seem to be to blame for much of the wide-ranging sell-off in the market, but Nvidia itself bears some of the responsibility here for fanning pessimism in the semiconductor space.
While Nvidia closed the day up yesterday, at one point on Thursday the stock was down as much as 5% in response to the announcement that fiscal second-quarter 2023 sales grew only 3% year over year, missing analyst expectations, and that GAAP earnings per share tumbled 72% year over year to just $0.26.
Commenting on the results Wednesday evening, CEO Jensen Huang largely blamed "supply chain transitions in a challenging macro environment" for the disappointing results. But we've been dealing with constrained supply chains for a couple of years now, and up until this week, they hadn't slowed Nvidia down much. Rather, what seems to be ailing Nvidia -- and what could ail AMD and Applied Materials next -- is a pretty pronounced decline in demand for semiconductor chips, and in the prices chipmakers can command for them.
Gross profit margins on Nvidia's sales simply shriveled in the second quarter -- down 2,130 basis points to just 43.5% -- as operating costs rose.
Now what
Nvidia seems to see this as a temporary phenomenon, predicting that gross margins will shoot right back up in the third quarter to 62.4%, close to where they were in the first quarter. Still, revenue seems likely to be light -- $5.9 billion, plus or minus 2%, according to management. That's roughly $1 billion less than what Wall Street had been predicting, with the gaming and professional visualization segments dragging on the rest of the business as data centers and automotive try to pick up the slack.
Here's the good news: Nvidia ascribed much of its weakness in gross margins in the second quarter to the company's attempt to sell down and clear out excess inventory of gaming chips. That would explain the steep falloff in gross margins in the second quarter, and make Nvidia's prediction that margins will bounce back in the third quarter seem more reasonable.
NASDAQ: AMAT
Key Data Points
Wall Street seems to agree with the logic. Analysts at investment bank Piper Sandler, for example, say Nvidia is swallowing "tough medicine" in order to ensure that the third quarter marks the revenue trough for the business. And Citigroup predicts that by early next year, we could see growth resume even in the beleaguered gaming segment.
If they're right about that, then the stock of Nvidia -- and competitors like AMD, and the companies that need semiconductor demand to grow, like Applied Materials -- should be able to bounce back later this year.
But if Wall Street's analysts are wrong about semiconductor sales rebounding late this year or early next year, I'd feel a whole lot more comfortable owning shares of Applied Materials stock at 13.5 times trailing earnings today, than either Nvidia or AMD, at 46x and 39x earnings, respectively.
Just in case the worst happens, make sure you have an adequate margin of safety to protect yourself.
