Shares of Nvidia (NVDA 3.71%) have been in red-hot form over the past three months, with the chipmaker's stock rising 50% as investors seem to have regained confidence in semiconductor stocks following a terrible 2022.
The PHLX Semiconductor Sector index is up an impressive 25% in the past three months, which might seem a tad surprising given the bleak semiconductor industry outlook for 2023. Gartner, for instance, forecasts a 3.6% decline in global semiconductor revenue this year.
Does this mean that Nvidia's rally could be cut short, especially considering the massive headwind it faces in the form of weak graphics card demand? Or should investors continue buying the stock in the hope that the chipmaker will sustain its momentum and crush the market in 2023? Let's find out.
Nvidia gets a price-target hike, but can it deliver?
Barclays has adopted a positive stance on chipmakers with exposure to the data center, smartphone, and personal computer (PC) markets.
Nvidia relies on data centers and PCs for a nice chunk of its revenue. It also stands to gain from the growing adoption of artificial-intelligence (AI) applications, which require massive computing power in data centers that Nvidia's graphics processing units (GPUs) provide. As a result, Barclays has increased its price target on Nvidia stock to $250 from $170. The updated price target represents a 29% upside from current levels.
It won't be surprising to see the data center business turn out to be a key growth driver for Nvidia this year since it has been doing the heavy lifting for the company at a time when the gaming business is in the soup. In the third quarter of fiscal 2023, for instance, Nvidia's data center revenue increased 31% year over year while gaming revenue was down 51%.
Moreover, the data center business produced 64% of the chipmaker's total revenue, which means that it can move the needle in a big way for the company.
A strong showing from the data center business will be the key to Nvidia's growth in fiscal 2024. Analysts anticipate the company will deliver a 9% increase in revenue in fiscal 2024 to $29.3 billion, as well as a 32% spike in earnings. Those numbers would be a major improvement over fiscal 2023's estimate of flat top-line growth and a 26% drop in earnings per share.
Nvidia may be able to meet or even exceed Wall Street's estimates as it is about to enter a new market. The chipmaker's ARM server CPUs (central processing units) are set to hit the market in 2023, and Nvidia is attacking this market at an opportune moment. ARM CPUs are expected to capture a quarter of the server processor market by 2025 as compared to 7.1% in the second quarter of 2022.
More importantly, the ARM server CPU market is expected to generate $16 billion in revenue in 2023, a number that could jump to $82 billion by 2030 as per estimates compiled by Statista. So the addition of ARM server processors to Nvidia's portfolio should give the company a solid opportunity to amplify its data center revenue from this year.
Also, Nvidia has a tight grip on the market for data-center graphics processing units (GPUs). IDC estimates that the company was sitting on a massive 91% of the enterprise GPU market in 2021, while rival Advanced Micro Devices' share was in the single digits.
Grand View Research estimates that sales of data center GPUs could increase at an annual rate of 23.5% through 2030 thanks to their use in supercomputers, AI applications, medical imaging, and drug research, among other areas.
So the healthy prospects of the data center CPU and GPU market could be a nice tailwind for Nvidia this year and beyond. The company might be able to deliver faster-than-expected growth thanks to the data center catalyst, and the stock could head higher as a result. But the bad news for investors is that Nvidia's rally has made the stock very expensive.
Nvidia stock needs to justify its price
Nvidia stock is now trading at a rich valuation. The chipmaker has a price-to-sales ratio of 17 and a price-to-earnings (P/E) ratio of 82. The current earnings multiple is way higher than Nvidia's five-year average P/E of 59. Meanwhile, the sales multiple is also well above the S&P 500's reading of 2.4.
Investors might not be comfortable paying so much for a company that's facing a massive threat in one of its key businesses. And Nvidia's recent results haven't been all that inspiring to warrant such a steep valuation. Had the company been firing on all cylinders and growing rapidly, growth investors may have considered putting their money on Nvidia.
But that isn't the case, and Nvidia will have to substantially accelerate its growth to justify its valuation. That's why investors who have missed its recent rally might want to wait for a better entry point since it is too late to buy this tech stock right now.
