Nvidia Stock: Avoid the Pitfalls (NASDAQ: NVDA ) | Private Equity Weekly

introduce

It was clear to me that I was far from the best position to call again to avoid NVIDIA Corporation (NASDAQ: NVDA) stock because my last two “sell” calls have aged like milk:

It’s been three months since my last bearish article on the company, and the stock has nearly doubled, going against my concerns about growth and seasonality. Even though I’ve made some poor decisions in the past, I decided to update my NVDA coverage again and give the Bulls some food for thought.

In my line of work, arriving early means making mistakes, but I still believe my thesis has a much better chance of coming to fruition now.

Why do I think so?

Let me start with some notes from the field.As I write these words, NVDA stock is correcting It’s up a whopping 75% since the start of the year, outperforming all other stocks in the “Magnificent 7” group. We absolutely have to view the entire price action in terms of the company’s impact on the market as a whole, as Nvidia’s share of the Nasdaq Composite recently reached 6.5% (Ingredients: IND), represented by Invesco QQQ Trust ETF (QQ). also, According to Jim BiancoAmong them, NVIDIA accounts for more than 60% of QQQ’s total market value change this year, while “NASDAQ 96” has fallen by about 1.1% so far this year:

Jim’s small study highlights not only NVDA’s influence on QQQ, but also the latest warning signs and sentiment. He emphasized the role of the “2X Long Nvidia” ETF (GraniteShares 2x Long NVDA Daily ETF (NVDL)), a leveraged fund tied to Nvidia’s performance that has seen a surge in assets and trading volume in recent weeks. In his view, the giant red candle on the NVDL chart indicates that leveraged market participants may be exiting — which could put further downward pressure on Nvidia’s stock price (and the tech-driven market as a whole).

This is a very interesting finding, but in my opinion, it’s just the tip of the iceberg. These conclusions from the field of behavioral finance and the analysis of possible crowd behavior are very important, but are not by far the most important tool for financial analysis/forecasting. It’s more important to look at the boring facts and figures.

If you’re an Nvidia bull, you should have no problem with my assumptions below, as I’m going to assume the most optimistic scenario.

The current consensus assumes that NVDA’s revenue will grow at a CAGR of approximately 10.9% over the next 5 years (FY25-29). I’m assuming a CAGR of close to 15% over the same period. Furthermore, assuming the company’s market-leading position does not change, EBIT margin will reach 66% this year and average 60% over the next four years. Nvidia is in a fairly cyclical industry, so my assumptions seem pretty optimistic.

As a ratio of D&A to sales, I took the average of recent years, which is much higher than the TTM value. My goal in doing this is to increase the company’s free cash flow.

It is logical to assume that the more stable a company’s future earnings are, the less favorable tax legislation will be for it. However, I think the effective tax rate will tend to average 12.5%.

Therefore, my main hypotheses can be summarized as follows:

I want to use Templates for FinChat Because it seems to be one of the best options for DCF napkin calculations. This is what my input looks like in the model:

Now let’s look at discount rates.We assume NVDA’s current cost of debt in the market is 4% – this is unrealistic and overly optimistic as the current yield on 10-year government bonds is 4.1%. We also assume that the market risk premium (MRP) is also 4% – which is also very optimistic because, by the logic of things, it should be higher. But even with such optimistic assumptions, the WACC is still 11%:

After discounting projected FCF and the optimistic assumption that the company’s free cash flow will grow at a perpetual 7% rate (which is too high), it turns out that the stock is 20.7% overvalued today:

Assuming an exit multiple of 25-30x EV/FCF, this would result in an overvaluation of approximately 19.5%:

So, you saw it for yourself: I actually tried to intentionally inflate the company’s forecast numbers to account for the risk that the current consensus forecast was missing something. But even against the backdrop of my bullish inputs, NVDA stock is still quite expensive today. Therefore, if we adjust my findings to more realistic and likely hypotheses, the resulting overestimation may increase significantly. This is the main reason to stay away from this stock and not buy it now that the price is slightly lower, as its valuation is still unreasonable.

You can also add the results of your comparative evaluation here. I took the chart below from my Seeking Alpha colleague Oakoff Investments, who recently did an excellent job on Amazon.com, Inc. (AMZN) stock.

What do we see in this picture? Clearly, NVDA’s point is at the right end of the chart, which compares long-term P/E and EPS growth figures for all companies in the “Magnificent 7” group. This means that NVDA is the most expensive stock in the sample. Investors wouldn’t be too worried if Nvidia’s long-term growth rate was higher than other companies – but in fact, they’re even losing out to Alphabet Inc. (GOOG), (GOOGL).

In my opinion, Nvidia’s continued rise is a trap for buyers of the current stock price. According to most existing valuation methodologies, the stock is overvalued even in a bull market scenario. At the same time, competition in the AI ​​chip market is also intensifying. According to market reportsIntel is planning New AI chip Meta launched this year want to use has its own custom chips in its data centers, and Google Developed Cloud tensor processing unit that can be used to train AI models. This is why my optimistic predictions in the DCF model may turn out to be completely wrong.

Where could I be wrong?

My analysis shows NVDA’s huge influence on the broader market. However, this effect could also have the opposite effect, with market sentiment and broader economic factors potentially driving NVDA’s stock price beyond my expectations. Therefore, any unexpected positive developments in the market or changes in investor sentiment could push NVDA’s stock price higher and weaken my bearish view today.

I noted above that any breakthroughs or advances from competitors such as Intel, Meta, or Google could erode NVDA’s market share and disrupt its growth trajectory. But what if competitors’ efforts aren’t innovative enough to challenge NVDA’s lead? Argus Research analysts wrote in a recent report on Nvidia (proprietary source):

“NVIDIA’s expertise, market leadership and continued investment in new technologies put it generations ahead of its competitors and give it a sustainable advantage in the market.”

Therefore, the valuation premium we see today is likely to last longer than today’s consensus pricing.

Although I tried to explain the upside potential by making overly optimistic (in my opinion) assumptions in the DCF analysis, there are risks to my assumption of 15% sales growth over the next 5 years, a stable market position and an optimistic outlook. EBIT margins may actually prove to be too low. Additionally, the resulting WACC of 11% may be too high. For example, here are the results of a DCF valuation based on a WACC of just 7% and a perpetual FCF growth rate of 4%:

judgment

While there are many upside risks to my thesis today, I tend to think Nvidia stock is too expensive. I know many of you may have heard these words when the stock was at $200, then $300, $400, and so on. But today there is an objective reality that cannot be ignored. First, this is a parabolic rise in stock prices that, according to market logic, will not last forever. At some point, speculators should start unwinding their positions, and judging by recent market data, this process may have already begun. Second, even if we include unrealistic forward forecasts in the DCF model, stocks will be overvalued in most cases. Yes, the model’s final output appears to be sensitive to adjustments in key assumptions, but even if we look at the COMPs analysis, the significant overestimation of NVDA is confirmed.

Therefore, today I am reaffirming my previous “sell” rating on Nvidia shares and calling for avoiding this growth trap.

thanks for reading!