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Nvidia: Beware the Steep Valuation Despite Favorable Prospects
Stock Analysis & Ideas

Nvidia: Beware the Steep Valuation Despite Favorable Prospects

Nvidia (NVDA) continues to trade near record levels following the stock’s extended rally over the past few years. Despite the ongoing concerns, including COVID-19, its steep valuation levels remain. The company keeps benefiting significantly from the growing adoption of cryptos, with demand for its graphics cards staying at sky-high levels due to their contemporary utilization of mining coins.

At the same time, the industry’s lasting supply chain issues and shortages have additionally broadened the disproportionally higher demand to supply gap, feeding Nvidia with tremendous pricing power. Try building a PC these days, and upon deciding which graphics card to buy, you will quickly realize how absurd their prices have become.

While Nvidia has been pushing to boost its total production capabilities to meet the underlying, growing demand, its huge pricing leverage alone has led to swift growth in its financials and richer margins by the quarter.

In my view, Nvidia’s card will play a critical role in digitalization and AR/VR applications in the coming years. For context, the number of global virtual reality device shipments is expected to grow at a CAGR of 33.85% through 2026. That said, I can’t but remain neutral to the stock solely due to its rather steep valuation, which reduces investors’ margin of safety at its current levels. (See Analysts’ Top Stocks on TipRanks)

Nvidia’s Latest Results

The company’s latest results were once again quite strong, with revenues growing 50% year-over-year to $7.1 billion, or 9% from the previous quarter. Powered by evolving economies of scale and its fantastic pricing power as of late, Nvidia’s margins have also repeatedly been expanding.

Gross margins climbed to 67%, a 30 basis points increase sequentially, or an impressive 150 basis points increase compared to last year. Consequently, operating income and net income also skyrocketed. Nvidia’s net income increased 13% quarter-over-quarter and 62% compared to Q3 2020. EPS came in at $1.17, 60% higher year-over-year as well.

Is NVDA Stock Too Expensive?

Nobody can argue that Nvidia’s growth is nothing but outstanding. Nvidia is well-positioned to profit extensively from several trends, some of which have only just started to gain traction, such as VR/AR.

Meta Platfroms’ (FB) all-in bet on the development of the Metaverse is a testament to the potential size of this new market. In addition, Nvidia’s recent acquisition of Omniverse Avatar should be a great asset in this growing market moving forward. There is even a virtual interview through Omniverse with Nvidia’s CEO, which showcases the technology platform’s capabilities in generating interactive AI avatars.

Additionally, the crypto-economy should continue to gain heightened adoption, which will likely sustain the ongoing shortage in graphics cards, allowing Nvidia to retain its very beneficial pricing power over the next few years.

However, we can’t just ignore that the stock is currently trading at a trailing P/E ratio of around 93x and a forward P/E ratio near 60x. Hence, Nvidia’s total return prospects could be relatively thin for current investors.

Furthermore, capital returns remain insignificant to counterbalance a probable valuation compression. The stock’s dividend remains inconsequential and mostly plays the role of a “token,” while buybacks would hardly benefit shareholders at the stock’s current valuation levels, in my opinion.

Wall Street’s Take

Turning to Wall Street, Nvidia has a Strong Buy consensus rating, based on 24 Buys and two Holds assigned in the past three months. At $360.17, the average Nvidia price target implies 19% upside potential.

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Disclosure: At the time of publication, Nikolaos Sismanis did not have a position in any of the securities mentioned in this article.

Disclaimer: The information contained in this article represents the views and opinion of the writer only, and not the views or opinion of TipRanks or its affiliates  Read full disclaimer >

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