Some companies are simply unpredictable in the stock market. In the past two quarters, I've written about how Nvidia (NVDA -0.29%) may have difficulty meeting expectations. Both times, it blew projections out of the water. And now Nvidia expects to report record revenue again in Q3 after just doing it in Q2.
Because Nvidia is highly unpredictable, is it worth an investment now? Or does it need to stay in the "too difficult to understand" category? Let's find out.
Another quarter, another unbelievable projection
Nvidia's primary products are GPUs (graphics processing units). While consumers may purchase one of these hardware pieces to power their gaming desktop, companies with data center and artificial intelligence (AI) aspirations buy thousands of these GPUs at a time.
This has been the primary tailwind behind Nvidia's latest rise, as its GPUs are the top choice for everything AI. This was displayed during its FY 2024 Q2 results (ending July 30), as data center (including AI GPUs) revenue was up 141% year over year to $10.3 billion. By itself, this division would have had the greatest quarter in Nvidia's history, but other segments like gaming were up 11% this quarter, reversing the trend seen over the past year.
But once again, guidance overshadowed actual results, as Nvidia expects to generate even more revenue in Q3. Management guided for $16 billion in revenue, indicating revenue growth of 171%. That makes Q2's 101% growth look minuscule, and was the type of guidance Nvidia needed to maintain its ultra-premium valuation.
With this great business comes a lot of questions. Nvidia's business is cyclical, and various industry booms (like the cryptocurrency industry in 2017 and 2020) have caused momentary spikes in revenue followed by a drawdown.
NVDA Revenue (TTM) data by YCharts
The question is, how long will AI demand last? I don't have the answer, but if I did, that would significantly change the price I'm willing (or unwilling) to pay for Nvidia stock. Eventually, the AI infrastructure will be built out, and this immediate arms race spending will dry up. That's the situation I'm most worried about when considering whether I should take a position in Nvidia.
Because right now, the stock looks quite expensive.
Nvidia requires significant growth to be valued reasonably
Although Nvidia posted great earnings per share (EPS) in Q2 ($2.48, up 202% year over year), it hasn't consistently had solid numbers over the past year, so the trailing price-to-earnings (P/E) ratio is skewed. Instead, investors should utilize the forward P/E ratio, as it factors in the substantial business transformation Nvidia is undergoing. From this perspective, Nvidia's stock doesn't look too pricey.
NVDA PE Ratio (Forward) data by YCharts
However, this requires Nvidia to grow significantly over the next year and continue to see strong AI demand. But what happens if that AI demand drops in the future? Nvidia won't be nearly as profitable and will become expensive again.
As a result, I will sit on the sidelines on this one. There are just too many unknowns, and while Nvidia may continue to post unbelievable results, its history tells me a downturn is coming, eventually. Now, how far away that is coming is a question I have no answer for.
If you want to own Nvidia stock (or already do), I would be cautious and not let it become too much of a portfolio weighting. But owning some shares isn't a bad idea; it's just a position you'll have to be diligent with.
