Nvidia Corp. (NVDA) has experienced a remarkable run-up in its stock price.
To say the stock has been on a roll would be an understatement. Nvidia has gained 550 percent since the start of last year, added $2 trillion in market value over the past 15 months, and is responsible for about 29 percent of the S&P 500’s year-to-date gains.
After such a historic run, it’s natural to wonder if the stock is ahead of itself. The bear case is tough to make, though, because Nvidia isn’t just another meme stock run wild. It’s a real company with powerful fundamental tailwinds. Revenue doubled in the last fiscal year and is projected to rise another 81% this year. Revenue growth like that for such a large company is extremely rare.
Nvidia also has an exciting story that easily captures the imagination of investors. The world’s most valuable semiconductor company is at the center of a corporate arms race to boost computing power for AI workloads. The biggest companies in Silicon Valley are virtually tripping over each other to buy Nvidia’s most coveted chips.
Ever since ChatGPT debuted to the broad public, it’s been widely assumed that AI will be a very big market. But nobody knows precisely how big the market will become, or what Nvidia’s long-term market share will be. This allows investors to project whatever stratospheric growth rate assumptions they wish, and explains why the shares trade at a nosebleed valuation multiple of 37 times sales.
If you’re a long-term shareholder of Nvidia, congratulations—it’s been a wonderful ride. But how long can the vertical ascent continue?
In the Pixar movie Toy Story, there’s a quirky character named Buzz Lightyear. He exudes boundless enthusiasm for space exploration, frequently boasting that he can travel “to infinity and beyond.”
Yet, Buzz never really goes to infinity and beyond. That’s just a story in his head. A figment of his imagination. In reality, he was a toy stricken with a case of ebullient delusion.
Nvidia bulls aren’t as delusional as Buzz, in my opinion. But they may be too giddy for their own good. No stock goes up to infinity, and neither will Nvidia.
The semiconductor industry is notoriously volatile and prone to boom and bust cycles. Chipmakers have struggled at times to meet short-term swings in demand with long-term levels of production capacity, which can cause periods of oversupply and shortages.
Currently, the industry is in a boom period. But it’s unclear how long the current demand wave will last. Any slowdown in buying by major data center owners such as Microsoft, Amazon and Alphabet could dent Nvidia’s revenue and growth estimates.
Nvidia, whose name is partly inspired by the Latin word for envy, is currently the most envied company on the planet. Success breeds competition. Numerous companies are now rushing to get a bigger piece of the AI chip market. For instance, Advanced Micro Devices launched its AI-accelerator last year and is forecasting significant revenue growth. Intel Corp. also has its own AI chips it will attempt to push into the marketplace.
According to Reuters, tech giants including Intel, Qualcomm and Google have formed a consortium named the UXL Foundation to “build a suite of software and tools that will be able to power multiple types of AI accelerator chips.”
Nvidia may also face competition from companies that don’t even exist yet. Earlier this year, there were reports that OpenAI’s CEO, Sam Altman, was seeking to raise trillions of dollars to significantly expand the world’s supply of semiconductor chips.
Another risk is that macro market conditions change. That’s because the factors that have been driving Nvidia’s manic price action stretch beyond just the company itself.
We have been in an era of excess liquidity ever since the Fed decided to massively expand its balance sheet during the 2020 pandemic. And we also live in an era where passive investing has become a lot more popular, which favors stocks with the strongest momentum. When abundant liquidity mixes with the valuation agnostic investing approach used to construct passive portfolios, it’s an easy environment to see dramatic valuation overshoots.
A lesson from the Tech Bubble that burst in 2000 was that it usually doesn’t pay to buy stocks that trade over ten times sales. At 37 times sales, Nvidia is well beyond that valuation. For me at least, that statistic alone says buyer beware. I don’t care how great Nvidia’s chips are, or how revolutionary the AI theme may be. I just don’t invest in stocks at that high of a valuation, because history shows it usually doesn’t work out well. If anyone has a backtest that disproves that notion, I’d love to see it.
Valuation matters a lot over the long run, but it has almost no signaling power in the short run. If Nvidia can trade at 37 times sales, it can just as easily trade at 107 times sales.
However, even from a trading perspective there are some yellow lights beginning to flash.
Year-to-date, the momentum factor has dramatically outperformed, which may leave it ripe for a correction. Global PMI surveys appear to be bottoming and commodities are breaking out to the upside. If inflation heats up again, it could easily cause a rotation out of high flying tech stocks into other areas of the market. Since Nvidia is the posterchild for momentum in this market, that could lead to an uncomfortable correction.
A trend is only your friend until it ends. One toolkit that helps diagnose when trend reversals are more likely to occur is the DeMark Indicators. I’ve written about these indicators before when I was attempting to sniff out a potential market bottom.
This week, Nvidia printed 13 exhaustion signals using DeMark’s TD Sequential and TD Combo indicators. If I were long Nvidia, this would concern me, because the stock flipped to bearish trend right after the 13s, and the next clear line of support is way down at $615. Another bearish trading signal is that momentum waned over the last month as the stock was making new highs (see bottom panel below). Wall Street traders call this a ‘negative divergence’.
Nvidia is a great company, but that doesn’t make it a great investment at any price. If you’re long, this may be a good time to consider taking profits. And if you’re considering buying shares for the first time, you may want to patiently wait for a better entry point.
