After falling about 50% in 2022, Nvidia's (NVDA -3.33%) share prices have rebounded 61% so far this year and significantly outperformed the S&P 500 year to date. Does that mean it's already too late to buy?
Sales of graphics processing units (GPUs) have been weak over the past year, and that was reflected in the company's recent earnings report, with fiscal fourth-quarter revenue down 21% year over year.
However, it's a good sign that Nvidia grew revenue sequentially over the previous quarter, which could mean the business is navigating through the trough in the demand cycle right now. Let's look at the opportunities ahead to see if that justifies buying the stock at the current highs.
Artificial intelligence is the biggest story right now
Nvidia's total revenue climbed back over $6 billion, up from $5.9 billion in the previous quarter. While gaming GPUs could be poised for a stronger year after segment revenue jumped 16% quarter over quarter, the data center business is the one to watch.
Nvidia's largest revenue source is weakening right now. While data center revenue was up 11% year over year to $3.6 billion in the fiscal fourth quarter of 2023, it was down from $3.8 billion in fiscal Q3.
Image source: Nvidia.
The softening in the data center segment didn't faze investors, because management indicated on the earnings call that the weakness is a temporary issue.
Some cloud service providers paused their spending at the end of the year to recalculate their budgets due to the uncertainties in the economy. But management indicated that end-market demand for GPUs, particularly for artificial intelligence (AI) infrastructure, is strong.
Cloud companies may slow their spending for a few quarters, but investment in AI will continue to grow over time. A recent forecast from the International Data Corp. (IDC) estimates that spending on hardware, software, and services for AI applications will increase from $118 billion in 2022 to over $300 billion by 2026. IDC says the pandemic accelerated the use of AI because businesses figured out the value-enhancing efficiencies and capabilities they can gain with the technology. This is a major growth catalyst for Nvidia over the long term.
Nvidia's new flagship H100 GPU for data centers is seeing strong adoption by organizations for large data workloads, such as natural language processing. The company is believed to be the supplier of GPUs that power OpenAI's popular ChatGPT language generator.
Nvidia's H100 GPU using the latest Hopper architecture. Image source: Nvidia.
Is the data center recovery already priced in?
After rising sharply this year, Nvidia's valuation is not as cheap as it was at the end of 2022. The stock currently trades at a high multiple of 52 times expected earnings based on this year's Wall Street estimates. That looks expensive even if we assume the company can increase its earnings by more than 20% per year going forward, as analysts expect. As a result, the stock's gains could be limited for the rest of the year.
On the other hand, the expanding AI market suggests that Nvidia can grow at robust rates for many years, perhaps for a longer period than analysts expect, which is why the stock deserves a premium.
If you're interested in starting a position in the stock, a safe course of action might be to see how things play out in the near term with Nvidia's data center growth. If it takes longer for cloud companies to pick up spending again, that could drag on the stock and might provide a better price to buy later this year.
Still, there's nothing wrong with getting skin in the game and adding shares over time. But I would certainly start small relative to your other investments, especially when there are other undervalued growth stocks with bright futures selling at attractive valuations.
