Shares of Nvidia (NASDAQ: NVDA), a leading provider of graphics and artificial intelligence (AI) chips, have recently experienced a notable pullback. After surging from under $500 at the start of the year to a 52-week high of $974, the stock has retreated by nearly 11% as of the latest update. Given the significant momentum in both the stock price and the underlying business, some investors may be contemplating whether now is an opportune moment to acquire shares.
While Nvidia has indeed demonstrated remarkable sales and earnings growth, potential investors should exercise caution before seizing this dip. Although there’s a possibility that the stock could rebound sharply and maintain its upward trajectory, its premium valuation and a staggering gain of over 200% in the past year suggest heightened risk for shareholders moving forward. In light of these factors, it may be prudent for investors to carefully assess the increased level of risk associated with holding Nvidia shares at this juncture.
The bull case
Despite the significant surge in Nvidia’s stock price, optimistic investors are keen to highlight that its revenue and earnings have experienced similar growth trajectories. Nvidia’s fiscal fourth-quarter revenue skyrocketed by 265% year over year, while its total fiscal 2024 revenue surged by 125%. Earnings per share during these periods saw remarkable increases of 765% and 586%, respectively. This remarkable momentum has been predominantly fueled by Nvidia’s data center business, which witnessed a remarkable 409% increase in fourth-quarter revenue and a 217% rise for the full year.
In essence, the bullish argument is straightforward: the exceptional growth justifies Nvidia’s current valuation, which stands at approximately 71 times earnings. Moreover, the company’s pioneering position and innovation leadership in the AI chip sector are widely acknowledged, further bolstering confidence in sustained growth prospects. Consequently, it is anticipated that Nvidia’s earnings per share will continue to expand at an average annual rate of 38% over the next five years, a trajectory that would undoubtedly validate the current valuation of the stock.
The bear case
The challenge lies in the highly uncertain trajectory of Nvidia’s long-term earnings growth. For instance, the competitive landscape in the AI chip sector remains unclear, raising concerns about potential margin pressures if competition intensifies, leading to a balancing of supply and demand and eroding pricing power. This scenario could result in a faster cooling off of earnings compared to sales growth.
Another significant risk stems from Nvidia’s customer concentration. As disclosed in its fiscal 2024 10-K filing with the Securities and Exchange Commission, a single customer contributed approximately 19% of the company’s total revenue for that fiscal year, a stark contrast to previous years where no customer accounted for more than 10% of total revenue. Such concentration underscores the vulnerability of Nvidia’s sales trends should this major customer decide to develop its own chips internally or switch to alternative chips in the future.
Moreover, investors should bear in mind that market dynamics are forward-looking, meaning the stock could begin to decline in anticipation of any future slowdown in sales growth or deterioration in demand, rather than waiting for it to materialize. Hence, even a hint of weakness in demand for Nvidia’s products could trigger a sell-off in shares.
Given these factors, investors might opt to wait for a potentially more favorable price point to purchase Nvidia shares, allowing for a buffer against unforeseen challenges or heightened competition. While Nvidia’s dominant market position and overall strength are impressive, the unpredictable nature of its future earnings suggests exercising patience in the hope of securing a more advantageous entry point in the future.
