What happened
Shares of Nvidia (NVDA 1.26%) fell 11.9% in September, according to S&P Global Market Intelligence. The chipmaker powerhouse suffered from a combination of troublesome rumors and difficult market conditions that weighed on semiconductor stocks and the tech sector in general. There wasn't major news about Nvidia last month, but its expensive valuation exposed the stock to volatility.
So what
Nvidia shares charged higher after an excellent quarterly earnings report in August. Investors were wowed by the company's revenue growth, which exploded 101% over the prior year and 88% over the prior quarter. That crushed Wall Street's forecasts, which were already bullish as the semiconductor industry leaned into a cyclical recovery. Nvidia outpaced its peers thanks to surging demand for its products, which are widely used in artificial intelligence and data center applications. Those happen to be some of the hottest topics among investors right now.
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Superior performance and exposure to AI-fueled investor optimism, and it may have pushed the stock's valuation into unsustainable territory. Nvidia's forward PE ratio climbed above 45, making it vulnerable to a pullback if investment sentiment soured.
That's exactly what happened in September, which was a "risk off" month. Major indexes dropped, with losses among growth stocks and the tech sector outpacing the market as a whole. Investor fears about slowing economic activity are ticking higher, and the Fed's hawkish September commentary dashed hopes that interest rate cuts could be around the corner. It sounds like the central bank will keep interest rates for the foreseeable future in an effort to combat inflation, and that's likely to create a difficult growth environment.
Unsurprisingly, that's bad news for growth stocks in the short term. High rates and slow growth usually go hand-in-hand with lower valuations in the equity market. Nvidia's valuation ratios were fairly high for a relatively mature company of that scale, even if it does have impressive sales growth catalysts.
That combined poorly with alarming rumors that came out last month. Some people are casting doubt on the demand for Nvidia's data center and AI products, and a slowdown in that market would crush the stock's most important growth catalyst right now. Channel checks suggest that these rumors could be unfounded, but bearish whispers can still cause damage in these situations.
Now what
Nvidia is a classic example of long-term potential combined with short term risk. The stock is more expensive relative to sales and earnings than most of the other largest companies by market cap. Investors have to pay that premium because Nvidia has more promising growth drivers, but it requires a leap of faith that the company will realize its potential over the next few years. That makes the stock more susceptible to losses when the market drops or if the company's growth narrative is challenged.
Nvidia's valuation still leaves room for big long-term returns, so bullish investors shouldn't be scared. However, it's still a higher-risk proposition than many of its peers. Buyers need to make sure that this stock is part of a portfolio allocation that's aligned with their risk tolerance and investment time horizon.
