For the last couple of years, the semiconductor industry has battled its share of challenges. From supply chain disruptions to chip shortages, companies like Nvidia (NVDA -2.48%) have seen better days. Well folks, things may have just turned around.
Nvidia reported financial results for its first quarter and the stock went absolutely bonkers, jumping 24% in a single day. There is a lot to unpack from the earnings report. Let's get to it.
Q1 at a glance
For Nvidia's first quarter ended April 30, the company posted total revenue of $7.2 billion, which represented a decline of 13% year over year. While data center revenue increased 14% year over year, reaching a record of $4.3 billion, the company's gaming segment declined a whopping 38% from the prior year. One thing to point out about Nvidia's all-time record in data center business is that its competition, namely Advanced Micro Devices, saw flat growth from its data center division during Q1.
Nvidia also generates revenue from two other segments: professional visualization and automotive. However, these two business units represent less than 10% of Nvidia's revenue base.
While revenue was down year over year, Nvidia did a good job of tightening its expenses. Operating expenses fell by 30%, far outpacing the decline in revenue. For this reason, profits were up 26% year over year and free cash flow doubled to $2.6 billion.
At the end of the day, these financial results are somewhat mundane. While profits are up, one could argue that this is merely driven by extreme cost reductions during a quarter of declining top-line growth. So, why is the stock headed toward the moon?
Image source: Getty Images.
AI is a powerful tailwind
Nvidia's guidance for the second quarter nearly caused me to spit my drink out. According to Yahoo! Finance, the original consensus Q2 revenue estimate was $7.2 billion. During the earnings call, investors learned that the company's Q2 guidance is $11 billion. No, that is not a typo.
Data is quickly becoming a more integral component of decision-making for businesses of all sizes, and demand for cloud computing infrastructure and AI development is on the rise. Just over the last several months, Big Tech companies such as Microsoft and Alphabet have been investing significant capital into AI applications. Honestly, it seems like every week a tech company announces a new use case for generative AI. And this is where Nvidia comes into play.
Nvidia sits at the nucleus of the AI revolution because as applications for machine learning and quantum computing continue to rise, demand for its chips and growing library of data center products should increase.
For this reason alone investors should be cheering on Nvidia. Artificial intelligence is clearly a major focus for companies across all different industries. The reliance on Nvidia to power these applications could be a major tailwind for the company for years to come.
Valuation is tricky
Nvidia currently trades for 218 times price to earnings (P/E). Using traditional valuation metrics on a growth stock like Nvidia can be a taxing exercise. Whether you analyze its P/E, price-to-sales (P/S) ratio, or PEG ratio, Nvidia stock appears overvalued by traditional benchmarks.
Sometimes when a stock really gets into gear, more and more buyers begin to pour in and the price gets pushed up to levels that are incongruent with fundamental logic. While I do not possess a crystal ball, I can say pretty confidently that Nvidia stock will see a pullback in the not-too-distant future. Why? Because momentum traders will be getting out. To me, that is the biggest risk here.
As a long-term investor, I don't fixate on an exact entry point for a stock. The investing adage of "time in the market is more important than timing the market" is a good rule to follow. But even with that said, it's incredibly difficult to justify buying a stock that is up over 100% year to date and is soaring another 25% post-earnings.
One could argue that Nvidia stock had fallen too much and reached oversold territory, thereby making its 2023 comeback reasonable. But I'm not buying that. This time last year Nvidia was trading at 45 times P/E, which is nearly three times more than the long-run average of the S&P 500. Given that the company's current P/E is now more than four times higher, investors can see that the capital markets have placed a premium on Nvidia for quite some time and it doesn't appear to be stopping. In fact, it could be argued that the tailwinds from AI are already priced into the stock.
While it can be challenging to find a comfortable point of entry, the core investment thesis for Nvidia should be tied to AI. If you are an investor looking for exposure to the next frontier in technology, know that Nvidia will certainly be a major player powering AI applications globally. For that reason, the stock should be on your radar and could deserve a spot in your portfolio at the right time.
