The last couple of years have been volatile for NVIDIA (NASDAQ:NVDA). It’s easy to forget that, though shares are still down close to 10% from the start of 2018 until this writing, the stock is up 180% over the trailing-three-year period. Who’s going to argue with that?
Quite a few people, it would seem.
The graphics processing unit (GPU) pioneer is still lapping results from its booming sales-and-crash cycle in 2018 driven by the cryptocurrency mining craze. And as a result of the somewhat skewed numbers, many investors are quick to cite trailing-12-month price-to-earnings and price-to-free-cash-flow ratios (basic profits after cash operating expense and capital expenditures are paid for) of 39.8 and 44.6, respectively, as too high. I believe those numbers will moderate as NVIDIA continues to rebound, but regardless, there’s good reason for primo pricing, here.
Cryptocurrency fallout and a data center build breather
First, it’s worth addressing some misunderstanding out there on NVIDIA’s biz. It’s always been in the premium chip aisle, opting to push the envelope with technology rather than duke it out with the competition on pricing. When something becomes too commoditized (remember when NVIDIA was in the car infotainment display business?), CEO Jensen Huang and company start looking elsewhere. It’s been a massively successful business strategy, one that everyone I’ve talked to at the company says it can pull off by developing and giving away open-source software that makes it easy for developers and engineers to put its cutting-edge hardware to use.
But sometimes a competitor makes some inroads and disrupts NVIDIA’s sales. This has happened as of late with the lower end of the gaming GPU line, with distant-second-place AMD making some advances. It offsets this by continuously forging ahead with new tech and built-in GPU capabilities (more on that in a minute). High-end gaming is important for NVIDIA, not just because it makes up half of revenue (51%, to be exact, in Q2 2020), but because of the other doors the GPU technology opens for it.
That was what happened with the cryptocurrency bubble and ensuing stock price pop last year — which, by the way, is the real reason for the 17% year-over-year revenue decline, and much less because of AMD competition, U.S.-China trade war issues, etc. Gaming GPUs can be purchased off any shelf or via any online store, and because NVIDIA makes them easy to deploy, developers find all sorts of uses for them (like crypto mining). In other words, not all those gaming GPU sales are strictly for gaming.
Simultaneous with the steep decline in cryptocurrency mining activity was a well-documented industrywide slowdown in data center build-out from the likes of heavyweights Amazon, Microsoft, Alphabet, and Facebook. Again, this was less about competitors taking sales away from NVIDIA and more about cloud computing giants taking a breather. It was an unfortunate convergence of events with the crypto bubble, but these things happen. The trade war isn’t helping either, but construction is nevertheless a cyclical business no matter the political scapegoat of choice at the moment.
All of this is to say that NVIDIA’s current valuation looks a little out of whack. Valuation is fluid though. It changes all the time based on quarterly financials and, in NVIDIA’s case, big stock price fluctuations like those that have been occurring for the last year or so. Plus, NVIDIA’s innovation-and-growth engine is still running and gearing up for another run higher, so valuation be darned.
Why a premium makes sense
It’s true that the data center and gaming GPU businesses were down 27% and 14%, respectively, from Q2 a year ago. However, both segments increased by 24% and 3% sequentially from the Q1 trough. There are areas of strength, too, like the early results of ray tracing and deep learning embedded in the company’s high-end gaming GPUs. Everyone initially panned the tech because video games hadn’t caught up yet, but that’s quickly changing. In the meantime, ray tracing found application elsewhere. The professional visualization (for architects, engineers, graphic artists, movie entertainment) segment is up 4% in the year since the release and grew 9% sequentially. Not too shabby.
Then there’s the automotive segment which, along with data centers, comprises NVIDIA’s autonomous machines, robotics, Internet of Things, and the edge computing business. Powered by AI that NVIDIA’s GPUs enable, those areas are only just beginning to get rolling. To wit, after a sleepy couple of years, the auto segment notched a 30% year-over-year and 26% sequential increase to $209 million in Q2 — good for 8% of total sales. With the AI at the edge and IoT device markets rolling, there’s likely to be plenty more growth where that came from. Remember, estimates are calling for several hundred million new connected devices to come online over the next few years alone.
So is NVIDIA a buy? If you plan on holding for the next year or less, there are certainly better values out there. Over the long term, though? Who cares about the current debate surrounding NVIDIA’s “mixed results” and stock valuation? The GPU maker is advancing computing power in a big way and is still one of the best investments in future tech there is.