Nvidia (NVDA 3.71%) has been in the spotlight multiple times over the past few months, and not for good reasons. The GPU (graphics processing unit) maker has dealt with demand issues in its gaming segment (which also includes cryptocurrency miners). With revenue falling 33% year over year in its second quarter (which ended Aug. 24) and gross margin taking a 20% dive, Nvidia's financials are the weakest they've been in many years.
The U.S. government last month forced more demand issues onto Nvidia. To minimize the spread of advanced artificial intelligence (AI) technology to China and Russia, the U.S. has banned the sale of Nvidia's most powerful (and expensive) chips to these countries. These sanctions are expected to hit Nvidia's revenue to the tune of around $400 million in Q3, depending on whether its customers in China and Russia are willing to substitute less powerful chips.
Issues like these helped drop Nvidia's stock price by 57% so far in 2022. Has the stock sold off enough, or perhaps even been oversold at this point? Let's look at Nvidia and see if now is the time to buy the stock.
Q3 will be ugly for Nvidia
Without the export ban, Nvidia expected about $5.9 billion in revenue during Q3. Now it's expecting around $5.5 billion. That creates a 23% revenue drop year over year. This drop won't likely affect Nvidia's projected gross margins (62.4%) nor its operating expenses. So with its updated revenue guidance, Nvidia's profit for the quarter should be around $750 million. That's a far cry from the nearly $3 billion profit in last year's Q3.
Clearly, Q3 will be bad. What's unclear is if any of the upcoming quarters will be any better. I doubt the U.S. government will reverse its action on its chip export ban, and gaming demand won't come roaring back. So this may be the first of many disappointing quarters for Nvidia's investors.
Nvidia still has a long way to fall before testing valuation lows
The short-term future isn't bright for Nvidia, but if the stock has reached a low valuation, it could be a buy. Because Nvidia isn't in a fully profitable state, looking at its earnings isn't as useful as looking at Nvidia's sales. From a price-to-sales (P/S) standpoint, Nvidia has reached a multi-year low.
NVDA PS Ratio data by YCharts
However, Nvidia experienced massive demand issues due to a cryptocurrency crash in 2019 (sound familiar?), and the stock reached a valuation low of about six times sales at its bottom. If Nvidia reaches this low again, the stock still needs to fall another 44%, implying a stock price of about $70. I'm not saying this will happen, but it provides a perspective on where Nvidia's valuation has been within the last five years.
To make matters worse, as Nvidia's revenue falls, its P/S ratio will rise due to the denominator shrinking. This action could potentially cause the stock price to fall even further as the P/S ratio attempts to stabilize.
With its valuation far from a low and the business trending in the wrong direction, there is just too much uncertainty right now for me to invest in Nvidia. I'm not convinced Nvidia's next year will be pretty, and with the economy not faring well, Nvidia's woes may just be beginning.
Long-term I think Nvidia will be alright, but I believe there will be much better entry points along the way.
