Is Nvidia Overvalued? Chipmaker Nvidia (NASDAQ:NVDA) was one of the hottest stocks of the past few years. As consumers were forced to stay home, the company’s gaming chip sales rose rapidly.
New investments in data centers also favored Nvidia during the same period. Now, however, the market is taking a second look at the company as the pandemic winds down and the forces that drove its stock price into the stratosphere subside.
To date, Nvidia has sold off by about 45 percent this year. At one time, this would have been a strong signal to buy this growth stock.
In light of recent earnings and revised forecasts, it appears that Nvidia may be overvalued even after this dramatic plunge. Will NVDA fall further?
Nvidia’s Business Challenges
Perhaps the biggest challenge for Nvidia is the massive decline of its gaming chip business.
In Q2, the company’s gaming chip revenue fell by a third. At the same time, operating margins also dropped to less than half of their previous levels. Both of these factors are concerning, as they point to a much less favorable future for Nvidia.
Overall revenue growth slowed to a crawl in the quarter, with the company bringing in just 3 percent more than it had the previous year.
While management has attempted to tie these issues to soft Chinese and European markets, it’s more likely that people are simply reducing their spending as COVID-related lockdowns end.
Consumers are spending less on gaming, squeezing the entire industry. Because of its heavy focus on gaming chips, Nvidia is taking a considerable hit to its business as a result of this market change.
Nvidia has also continued to spend large amounts of its capital on stock buybacks, a way to reward investors and arrest the stock’s fall. Ordinarily, buybacks are favorable for investors.
In Nvidia’s case, however, there’s a strong argument to be made that the company would be better off holding onto its cash.
In the Q2 earnings announcement, management justified ongoing buybacks on forecasts of future cash generation and growth. Given the company’s current revenue trajectory, however, this justification doesn’t seem to be warranted.
Finally, there’s a good chance that the slowdown will continue. The company’s Q3 forecast suggests a 17 percent revenue slump. With expenses still rising, investors can expect to see rocky performance from Nvidia in the next quarter and likely for the rest of 2022.
Nvidia Valuation Metrics
Nvidia is facing real business problems. The question, then, is whether its current valuation reflects those problems and makes it a worthwhile investment. Unfortunately, many of Nvidia’s valuation metrics suggest that it is considerably overvalued.
With a P/E ratio of 40.33 and a price-to-sales ratio of 13.67, Nvidia would have to deliver a great deal of growth in the coming few years to justify its current pricing.
While analysts estimate that the company will grow 22.8 percent on average over the next five years, that growth rate would still leave the stock seeming overvalued. If Nvidia fails to hit this growth target due to macroeconomic factors or a continued slowdown in gaming, its valuation could prove even less favorable.
Nvidia is also priced at over 17 times its book value. Given that the industry average is just 1.61 times book value, this metric is a glaring sign that Nvidia is still very likely overvalued.
Are There Still Reasons to Be Bullish?
Needless to say, Nvidia isn’t without its merits. The company’s free cash flow, for instance, has seen steady improvements over the last few years. In 2021, the company increased its FCF by 73.24 percent. This could be a very favorable long-term trend for investors if Nvidia can bring its margins back up.
Analyst forecasts also suggest that the stock could have a large amount of upside in the short term. The median target price of $215 from 38 NVDA analyst forecasts would give the stock an upside of 32.5 percent from the current price of $162.29. Without improvements in the underlying business, however, this increase could leave Nvidia even more overvalued in the long term.
For investors who are bullish on metaverse technology, there’s also a good long-term argument to be made for Nvidia in this field. As a major manufacturer of AI and graphics chips, Nvidia could play a key role in the hardware side of the metaverse’s development. Nvidia has also constructed its own virtual world, known as Omniverse, that could drive future revenues.
A final component of the bull case for Nvidia is the fact that some of the company’s problems could be temporary and driven by the current macroeconomic environment. Its lower margins, for instance, could improve after large chip orders it placed last year have been fulfilled.
A cooldown in inflation could also drive consumers to spend more on non-essentials, including gaming hardware.
Is Nvidia Overvalued and Is it a Sell?
Despite decent growth prospects ahead, Nvidia appears to be substantially overvalued at its current price.
The post-pandemic slowdown in gaming chip sales is likely a permanent factor that will require the market to downgrade its expectations for the company. At more than 40 times expected earnings, Nvidia is simply too expensive for the value it is likely to deliver.
The strongest argument for selling Nvidia comes from the recent actions of company insiders. In the last 12 months, nine insiders have sold a total of $438.75 million worth of Nvidia stock.
During the same period, not a single insider made a purchase. This strongly suggests that insiders are losing confidence in the company’s future and may be a good reason for investors to sell.
Investors who are bullish on metaverse technology may want to hold Nvidia for its potential in that area. Those who purchased it as a play on the gaming market, however, may want to consider selling the stock before the market adjusts to the new realities of Nvidia’s business.
Due to its significant overvaluation, the slowdown in gaming and clear lack of insider confidence, Nvidia appears to be a candidate to sell at the moment.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.