Sometimes, perfection just isn't good enough. It's hard to find a flaw in Nvidia's (NVDA -1.81%) latest results, but the stock is down just over 3% the day after it reported earnings.
Could this be a buying opportunity for what many consider the best artificial intelligence (AI) stock in the market? Let's find out.
Another quarter for the record books
Nvidia's primary products are its graphics processing units (GPUs), initially developed to process the intense calculations required to produce high-end gaming graphics. However, these units were also found suitable for other arduous tasks like engineering simulations, mining cryptocurrency, and now processing data for AI models.
Nvidia's CEO Jensen Huang has long anticipated the AI arms race and has built an ecosystem around Nvidia's GPUs, making them the best-in-class GPU for AI.
Its popularity has been evident throughout 2023 as Nvidia's revenue figures have exploded in response to the demand for AI computing power. Q3 of FY 2024 (ending Oct. 29) was no exception, as revenue increased by 206% to $18.1 billion.
Very few companies have gone from just under $6 billion in revenue to over $18 billion in just one year, but Nvidia has achieved that rare feat. It also surpassed management's expectations, as they only guided for $16 billion in Q3.
Furthermore, its success is expected to extend into Q4, as management projects an incredible $20 billion in revenue, representing 231% growth.
Alongside its incredible revenue growth, thanks to the AI rush, Nvidia's profits have dramatically risen due to an increase in Nvidia's gross margins. Nvidia's 70% gross margin in Q3 rivals many software companies, yet it's creating a physical product. Its 46% profit margin is also comparable to (if not exceeding) all the major software companies, making Nvidia one of the most profitable companies around the globe.
So, with Nvidia essentially doing what practically no other company has ever done, why is the stock down?
Investors want to see what 2024 has in store before buying more Nvidia
The problem with Nvidia is that the stock already had sky-high expectations. Before earnings, Nvidia traded at 116 times trailing earnings. For the full year, earnings per share is expected to come in around $4.02, valuing the company at just over 40 times estimates.
While 40 times forward earnings isn't necessarily cheap, it's not a bad price for a company executing as strongly as Nvidia. But this analysis ignores one massive warning flag: Nvidia's cyclicality.
NVDA Revenue (TTM) data by YCharts. TTM = trailing 12 months.
Nvidia is known to be a cyclical business as it goes through boom and bust cycles. Currently, Nvidia is booming, but how long will it last? Management noted on the Q3 conference call that half its data center revenue (about $7 billion) came from enterprise clients and consumer internet companies. Because these companies are buying Nvidia GPUs to build out their offerings, the question of how long this boom will last becomes consequential.
No one knows how many of these data centers will need to be built to meet AI demand. However, Nvidia's sales will likely decline once that limit is found.
This may have been attributed to the muted response to Nvidia's quarter, as the stock has been quite successful. The market has seen what it wants to see out of Nvidia in 2023; now, it's looking for 2024 (Nvidia's FY 2025) guidance.
It's also one reason I'm not buying Nvidia's stock now, as the red-hot demand could be nearing a peak. Conversely, it could just be getting started, making Nvidia a top stock to own for the next few years. This duality makes the stock difficult to assess, so I'm avoiding it.
If you're bullish on Nvidia and think it will be years before the AI buildout is complete, this pullback may be a buying opportunity. However, if you're not in tune with the AI buzz, Nvidia may be a stock to avoid due to its extreme volatility.
