Nvidia (NVDA 3.65%) stock is showing no signs of stopping. Share prices of the graphics card specialist have nearly doubled in 2023 despite warning signs from peers such as Advanced Micro Devices (AMD 2.44%) and Intel (INTC -0.38%), which are struggling due to weak personal computer (PC) and data center markets.
Both AMD and Intel's exposure to the PC market led to declines in their revenue and earnings last quarter.
- AMD reported a 9% year-over-year decline in revenue and a much bigger drop of 47% in earnings per share.
- Intel turned in a similarly woeful performance with a 36% year-over-year drop in revenue. Chipzilla also swung to an adjusted loss of $0.04 per share as compared to a profit of $0.87 per share in the year-ago period.
But these reports haven't played spoilsport for Nvidia stock despite the company's exposure to the PC market. The stock maintained its terrific momentum, which will be put to the test when the company releases its fiscal 2024 first-quarter results on May 24.
Nvidia needs to pass next week's litmus test to sustain its hot rally
Nvidia stock trades at a whopping 166 times trailing earnings thanks to its red-hot 2023 rally. For comparison, the Nasdaq-100 index sports an average price-to-earnings (P/E) ratio of 27. Nvidia, therefore, needs to deliver a solid set of results next week.
The good part is that Wall Street already priced a steep decline into Nvidia's revenue and earnings based on the guidance that the company issued in February 2023. Revenue is expected to drop 21% year over year to $6.5 billion, while earnings could contract 32% year over year to $0.92 per share.
There are signs that Nvidia could deliver better-than-expected results thanks to the massive demand for the company's artificial intelligence (AI) chips, which carry a massive price tag. However, a lot will hinge on Nvidia's outlook.
Consensus estimates point toward a turnaround in the company's fortunes in the current quarter. Its Q2 fiscal 2024 (ending July 31, 2023) revenue is expected to increase 6.5% year over year to $7.1 billion, while earnings are expected to more than double over the prior-year period to $1.06 per share. If Nvidia is unable to match -- or exceed -- these numbers, it won't be surprising to see investors pressing the panic button.
After all, the stock is extremely expensive right now, and Nvidia's recent quarterly performances don't justify that valuation. Investors have been bidding up the stock based on the hype around AI applications and how they are going to create terrific demand for Nvidia's chips. So if the company doesn't provide evidence that AI is moving the needle significantly and misses Wall Street's forecasts, the stock's outstanding rally could come to a grinding halt.
At the same time, investors shouldn't forget that a third of Nvidia's revenue comes from PC-centric businesses -- gaming and professional visualization. With PC sales declining at an alarming pace and a recovery still some time away, there is a chance of Nvidia's results and guidance not being up to analysts' expectations.
In simpler terms, the combination of Nvidia's steep valuation and headwinds in a substantial part of its business makes it a risky bet right now. So it might be too late for investors who have missed the rally so far to buy Nvidia.
But a potential trick up the company's sleeve could help it sustain its momentum.
AI spending could be Nvidia's trump card
Nvidia gets nearly 60% of its revenue from selling chips deployed in data centers. The sizable influence of the data center business on Nvidia's top line could help it overcome the PC market's weakness, especially considering that companies involved in the development of AI applications made a beeline for its chips.
Nvidia's H100 graphics processing unit (GPU), which is used for training large language models and powers generative AI applications such as chatbots, sells for as much as $40,000. This robust pricing power is the reason AI is expected to substantially boost Nvidia's growth in the coming years, potentially adding billions of dollars to the company's revenue.
The good part is that investors may witness the impact of AI-related demand on Nvidia's business very soon. DigiTimes reports that the semiconductor bellwether reportedly placed more orders for data center chips at foundry partner Taiwan Semiconductor Manufacturing, popularly known as TSMC. It is also worth noting that the demand for TSMC's 5nm chips, on which Nvidia's data center GPUs are based, increased by a big margin last quarter.
A closer look at how AI-related spending is booming gives us more reasons to believe that demand for Nvidia's expensive AI chips could be high. Market research firm IDC estimates that spending on AI-centric systems could increase 27% this year and hit $154 billion. More importantly, this momentum is expected to continue long term. IDC expects AI spending to increase by 27% a year through 2026 and to exceed $300 billion a year.
Meanwhile, the AI chip market alone is expected to grow to a whopping $227 billion a year by 2032 from just $17 billion last year, according to Precedence Research. Nvidia is the leading player in this market, with an estimated share of 95% of the market for GPUs used for machine learning applications, according to New Street Research. So it won't be surprising to see AI turning out to be a long-term catalyst for the stock.
What should investors do?
Nvidia's valuation suggests that it might be too late to buy the stock now given the potential headwinds discussed above. But if the company turns in a solid set of results and starts growing once again thanks to AI, growth stock investors should consider grabbing it. That's because Nvidia's forward P/E ratio of 64, which is less than half its trailing earnings multiple, indicates that its bottom line is set for solid growth.
More specifically, Nvidia's earnings are expected to jump 37% this year to $4.58 per share. The momentum is expected to continue in the next fiscal year as well with an estimated jump of 33% to $6.11 per share.
The company's solid pricing power in AI chips and robust demand for those chips could help Nvidia deliver such impressive growth. So if Nvidia regains its mojo thanks to AI, the stock could continue heading higher, in which case there's still an opportunity for investors to ride along.
