Nvidia: Prepare for $125-$200 Trading Window (NASDAQ:NVDA) – Seek Alpha | Jewelry Dukan

Daniel Chetroni

thesis

NVIDIA (NASDAQ:NASDAQ: NVDA) is currently in an interesting location. As a highly cyclical stock, it reacted more violently to the different phases of the economic cycle, as you can see in the chart below. At the beginning of For the past year, the stock has traded in bubble territory at nearly 90x P/E. Since then, stock prices are down more than 51% YTD and down more than 57% from their recent peak. In contrast, its close competitor AMD (AMD) “only” m41 YTD lost. And both NVDA and AMD’s losses are far worse than those of the tech sector QQQ.

At the same time, such a large price correction has largely emptied the bubble, and there’s a lot to be positive about the stock. First, the valuation is now much more reasonable (roughly 47x P/E, as detailed later) due to the large price corrections. Second, business fundamentals remain strong and growth prospects robust once the contraction phase is over. It plans to introduce a variety of new GPU, CPU, DPU, and robotic processors in the near future. Record volume was just reported for data centers and games recently. And such large volume can help significantly improve cost absorption once demand picks up again.

The rest of this article will weigh the pros and cons in more detail. But overall, my conclusion is that long-term investors like me can wait for a better opportunity, while swing investors can prepare for a trading window between $125 and $200 (converted to a P/E in the range of around 25x to 40x). in the next 1 or 2 years.

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Source: Search for Alpha

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Source: Yahoo Finance

The positive

As mentioned above, there are a lot of positive things to say about the stock. Here I just want to point out a few highlights that other SA writers talk less about.

First, NVDA enjoys tremendous flexibility in capital allocation, and the company is in such a strong financial position even if demand has been slowing recently. The chart below provides a summary of NVDA’s maintenance and growth CAPEX expenditures (see my previous article here for details on these concepts) over the last several years on a quarterly basis. As a result, the company is constantly reinvesting in excess of its maintenance and CAPEX requirements. Its CAPEX spend has consistently exceeded $200 million since 2020. And it peaked at $480 million in 2020 and is currently at $433 million, very close to the peak.

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Source: Search for Alpha

Second, the beauty of NVDA is that it doesn’t have to spend too much on maintenance investments. And so a large portion of CAPEX spending is growth investing. Maintenance investments (approximately by the total amount of depreciation) have averaged $186 million since 2018. And the total investments average $223 million. As a rough approximation, the difference of $37 million per quarter on average is the amount of growth investment it reinvests to fuel growth. Therefore, the growth CAPEX is about 20% of the total CAPEX spend. As a result, its owners’ income is much higher than its accounting income, since the growth investments should be added back to its owners’ income, which brings us to 3approx point below.

Third, its P/E ratio is lower than on the surface when considering its owners’ profits rather than accounting profits. The chart below shows NVDA’s true economic returns versus its accounting earnings per share, using a more rigorous methodology as outlined in my previous article here. The method used a method described in Greenwald’s book entitled Value Investing. As can be seen, NVDA owners’ earnings have consistently exceeded their accounting earnings. And the ratio between them has averaged 174% since 2017. The current OE to EPS ratio is 132%. Its current P/E is about 47 times on an accounting basis. And after adjusting for growth investments, the P/E based on owner earnings is “only” about 35.6 times.

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Source: Author based on Seeking Alpha Data

The negatives

Now the negatives.

First, there is little doubt that the stock is currently in the contraction phase of the business cycle, as you can clearly see in the chart below. I detailed the cyclical nature of business and the basic reasons behind the cycle in my previous article. The essentials are summarized below:

  • NVDA’s quarterly year-over-year operating revenue growth over the past 10 years shows two complete cycles over the past 10 years, each lasting approximately 3.5 to 4 years. The first expansion cycle peaked in early 2014 and peaked again in early 2018, resulting in a cycle length of about 4 years. And the second cycle peaked in early 2018 and peaked again in mid-2021 and lasted about 3.5 years.
  • The bottom of the previous contraction was reached in mid-2019. If history is any guidance, I expect the current contraction phase will also last around 4 years, meaning sometime later in 2022 and early 2023.

And consensus estimates seem to reflect the same view, as you can see from the next chart below. The earnings revisions of the last 3 months for the coming financial year paint a very pessimistic picture. No one expects EPS growth and a total of 37 analysts revised EPS downwards. Consensus EPS in 2024 and 2025 are now in the $4.6 to $5.6 range, about 32% and 39% lower than just 6 months ago.

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Source: Author based on Seeking Alpha Data

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Source: Search for alpha data

Second, the current valuation is more reasonable, but still high. As mentioned above, the recent correction has brought NVDA’s valuation into a more reasonable range both compared to its historical valuation and compared to its peers. That means it’s currently valued at about 47 times P/E on an accounting basis, or about 35.6 times on an owner basis, compared to about 90 times at the start of the year. But such an assessment is still expensive. As you can see, it’s at a 34% premium compared to AMD’s 35.3x P/E and a more than 100% premium compared to the NASDAQ 100’s 22.0x P/E.

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Source: Author based on Seeking Alpha Data

Final thoughts and other risks

To reiterate, my overall conclusion is that given the still elevated valuation and growth prospects, long-term investors like myself can wait for a better opportunity. However, some interesting swing trade opportunities could arise for short-term investors.

Given the highly cyclical nature of the business and also its stock prices (see chart below), I see a trading window between $125 and $200 over the next year or two. These prices translate to a P/E ratio in the range of around 25x to 40x based on consensus EPS estimates of between $4.6 and $5.6 as mentioned above. As you can see from the chart below, the stock is currently 57% down from its recent high. And over the past two decades, the stock has suffered corrections three to four times the size of this current one (depending on how you count). And the last three times happened in 2003, 2008 and 2011. And all of them took about 2 to 3 years for the price to reach the pre-correction level. If history is any guide, this is the amount of time I think the stock will last through this round of downturns as well.

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Source: Author based on Seeking Alpha Data

Finally risks. In addition to being highly cyclical, NVDA faces many other risks. These risks include macroeconomic risks, high inflation, supply chain disruptions, etc. NVDA’s products also have significant exposure to the cryptocurrency mining business. And its high-end, high-margin products are particularly sensitive to the possibility of a recession. All of these risks have been described in detail by other SA authors and also by me before. Here I will only focus on two risks specific to the trading window projected in this article.

First, timing the cycle accurately is never easy, even if the cycle has repeated regularly in the past. Second, as you can see from the chart below, the cycle can sometimes be so deep that a peak valuation can occur at the end of the cycle, as indicated by the green line below. And conversely, at peak prices, there can be a bottom valuation, as indicated by the red lines below. Both long-term investors and swing traders should be aware of such pitfalls.

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Source: Author based on Seeking Alpha Data

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