Semiconductor company Nvidia's (NVDA 3.46%) recent business performance has been explosive. The tech company, which benefits from the current boom in generative artificial intelligence (AI) due to its advanced AI chips in its data center segment, saw its fiscal third-quarter revenue rise 206% year over year to $18.1 billion. Data center revenue, specifically, increased 41% sequentially and 279% year over year to more than $14.5 billion.
As investors try to gauge how long Nvidia's staggering growth can persist and how to value the company following such a huge influx in demand for its products, many analysts have been raising their 12-month price targets for the stock. One of the most bullish Nvidia analysts recently updated their target for shares to $700 -- a level that would translate to more than 40% upside from here.
Here's what has this analyst so bullish.
The bull case
Bernstein analyst Stacy Rasgon has been an outspoken Nvidia bull for some time now, noting that the company is a must-own stock in the AI race and is widening its lead over competition. Further, Rasgon believes shares are "cheap" on a valuation basis given the company's rapidly improving fundamentals. This is particularly the case following Nvidia's fiscal third-quarter results, which Rasgon notes obliterated expectations and served as the basis for his 12-month price target upgrade for the stock -- from $675 to $700.
Addressing investors' concerns of a potential "air pocket" in sales at some point in the future following such a big surge in demand for AI chips, Rasgon believes Nvidia is still very early in the AI story, pushing this risk far into the future. While he does believe an air pocket is inevitable at some point, he thinks it's mostly a nonfactor compared to the stock's valuation today since he anticipates sales in five to 10 years will be "materially higher" than they are today.
Rasgon called out the company's strong guidance in its fiscal third-quarter report as evidence of management's visibility into continued strong growth rates ahead. Management guided for fiscal fourth-quarter revenue of $20 billion. In addition, management said in Nvidia's fiscal third-quarter earnings call that it not only thinks data center revenue can grow into 2024 but also "through 2025."
Investors should be cautious
There's no denying Nvidia's strong growth and management's upbeat view for the company. But there are still considerable risks for Nvidia that should keep investors skeptical. For instance, when demand for AI chips finally moderates, will prices for these chips come down sharply and profit margins narrow? Further, what if generative AI fails to increase company profits or enhance competitive positioning the way buyers of AI chips currently believe it will? If this happens, could Nvidia's data center revenue plummet in the years ahead?
The main point here is that there's a lot of guessing and speculation involved in anticipating how a new technology will unfold in the coming years.
To Rasgon's point, however, strong fundamental performance from Nvidia is making shares look more reasonably valued. The stock currently trades at just 25 times analysts' consensus forecast for non-GAAP (adjusted) earnings per share over the next 12 months. If Rasgon is right about the company's revenue likely being materially higher in five to 10 years, it may make sense to buy shares of the stock at this level.
Despite Rasgon's optimism, investors may want to take a more cautious approach. Waiting to see if the stock falls before buying shares could help reduce some of the valuation risk. Specifically, if shares were to fall to $400 or below, the risk-to-reward value proposition for the stock would be substantially better. Yet even at this level, investors may want to consider keeping their stakes in this unpredictable tech company small as a percentage of their total portfolios.
