NVIDIA May Be Worth More Than It Seems

For NVIDIA (Nasdaq: NVDA) investors, the sound that most likely comes to mind when thinking about the stock's recent performance is a low, guttural "ugh." It sounds a heck of a lot like the sound that one would make when getting punched in the stomach.

But even though NVIDIA's stock has been clobbered so far this year, investors may be premature in shoveling dirt on the company. The company just went through a very troublesome revamping of its graphics cards, and many investors have been stepping away for fear that the company will lose its competitive edge against tough foes like Advanced Micro Devices (NYSE: AMD).

Some NVIDIA-watchers now think the company's aggressive moves could be set to pay dividends, while the company has been generally seeing much better financial performance after a recession-induced drubbing.

Shares of NVIDIA currently change hands at $9.55 per share. Is that a good deal? Well, first we need to get an idea of what NVIDIA's shares are really worth.

It's a beautiful day in the neighborhood
One way to get an idea of what a stock might be worth is to check out how similar companies are valued. So let's take a look at how NVIDIA stacks up against some semiconductor industry peers.

Source: Capital IQ (a Standard & Poor's company) and Yahoo! Finance.
Average excludes NVIDIA.

Using each of those averages to back into a stock price for NVIDIA, and then taking the average across those results, we can come up with an estimated price per share of right around $13. So far, that looks pretty promising.

Of course looking on this chart, you might notice that on the basis of earnings-related measures -- P/E and PEG -- NVIDIA seems to be trading at a bit of a premium to its peers, but when we compare based on revenue and book value multiples, it looks like a screaming bargain. The reason for this is pretty simple -- NVIDIA's profit margin has recently fallen well below that of its peers and so investors aren't giving as much weight to the value of the company's revenue or equity.

So it would seem that the key for NVIDIA is getting those margins to rebound. By balancing out revenue and book value multiples -- which imply a margin rebound -- with earnings-based multiples -- which don't -- I've taken a bit of a middle ground on the issue.

Collecting the cash flow
An alternate way to value a stock is to do what's known as a discounted cash flow. Basically, this method projects free cash flow over the next 10 years and discounts the tally from each of those years back to what it would be worth today (since a dollar tomorrow is worth less to us than a dollar today).

Because a DCF is based largely on estimates (aka guesses) and it attempts to predict the future, it can be a fickle beast, and so its results are best used as guideposts rather than written-in-stone answers sent down from on high.

For NVIDIA's DCF, I used the following assumptions:

Source: Capital IQ (a Standard & Poor's company) Yahoo! Finance, and author's estimates.

While most of this is pretty standard fare when it comes to DCFs, the academically inclined would probably balk at the way I set the cost of equity. In a "classic" DCF, the cost of equity is set based on an equation that uses beta -- a measure of how volatile a stock is versus the rest of the market -- and a few other numbers that I tend to thumb my nose at.

But when you get right down to it, the cost of equity is the rate of return that investors demand to invest in the equity of that company. So I generally set the cost of equity equal to the rate of return that I'd like to see from that stock.

Based on the assumptions above, a simple DCF model spits out a per-share value just a bit more than $15 for NVIDIA's stock. I should note that a chunk of that value -- more than $3 per share -- comes from NVIDIA's hefty cash hoard. However, also beware that the company's cash flow has been very volatile and therefore tougher to model.

Do we have a winner?
The valuations that we've done here are pretty simple and, particularly when it comes to the DCF, investors would be well advised to play with the numbers further before making a final decision on NVIDIA's stock.

That said, the two valuation methods that we've used here suggest an intrinsic value for NVIDIA between $13 and $15 per share. The midpoint of that range is nearly 50% above NVIDIA's current share price, so it looks as if right now NVIDIA's stock is priced to be bought.

Do you agree that NVIDIA's stock is on sale? Head down to the comments section and share your thoughts.

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