People who want to buy $ Nvidia (NVDA.US) $ have been hesitant, and Nvidia will release its first-quarter fiscal 2023 earnings report on Wednesday (May 25), wanting to give the investment market a “reassurance” . The Nasdaq has fallen more than 27% year-to-date due to international geopolitical conflicts and expectations of an economic downturn.

The massive market correction has pushed many high-quality stocks to more reasonable valuations , such as Nvidia and AMD . Nvidia stock is down more than 43% year to date (while AMD is down more than 35%). Given its earnings growth, while its valuation has contracted further, many would-be investors are looking to dip into this high-growth stock.

However, research firm Envision Research advised investors not to increase their positions so early, and the current information is mixed . On the one hand, Nvidia’s rolling price-to-earnings ratio on a non-GAAP basis is now about 37, which is a far cry from the 100 it was not long ago. Its true case would be even lower, around 32.

Going forward, Nvidia has catalysts for growth, which should further depress valuations. It’s gearing up to launch a slew of new products to break into a high-margin, high-growth market. These products include the GeForce RTX 3050 desktop graphics card, the GeForce RTX 3080 graphics card, NVIDIA’s version 1.1 AI Enterprise, an end-to-end, cloud-native AI and data analytics software suite, and the recently launched NVIDIA SoC for millions of creators Nvidia Omniverse.

However, looking negatively, Nvidia’s valuation is still too high, and there are some fundamental risks that have to be guarded in the future. Chip shortages are likely to persist or even worsen; the recent slump in cryptocurrencies may reduce demand for Nvidia mining chips; looking at the macro economy, the dollar is becoming more attractive as the Fed raises interest rates to fight inflation. Exports may be dampened, and chances of a technical recession increase; several well-known companies including $Meta Platforms (FB.US)$ , $Netflix (NFLX.US)$ and $Peloton Interactive (PTON.US)$ recently announced they would not Hiring or even layoffs because of too much expansion or weaker-than-expected growth in demand. These are all likely to happen or affect Nvidia in the near future.

The following is a specific analysis of the above situation.

Nvidia’s EPS and Profits

Let’s talk about the positives first. Nvidia’s valuation has become more reasonable, and its product portfolio is excellent . Nvidia’s rolling price-to-earnings ratio is about 37 on a non-GAAP basis and about 43 on a GAAP basis. Granted, its valuation is still high, but considering that it is well below the high price-to-earnings ratio of over 100 not long ago, and the fact that the commonly used profit data does not accurately reflect its true profitability, this price-earnings ratio seems reasonable. As a high-growth stock that aggressively expands growth capital expenditures, Nvidia’s profit data greatly distorts its true profitability .

A simple comparison of Nvidia’s “free cash flow (FCF)” and “earnings per share (EPS)” shows the difference. Nvidia’s free cash flow (per share) has regularly exceeded earnings per share over the years. The ratio of free cash flow per share to earnings per share has been above 1, averaging about 145%. The chart below visually illustrates that, due to its high growth capital expenditures, just looking at free cash flow also underestimates its profits.

Nvidia’s high-growth capex

The key to figuring out profit is to differentiate between growth capex and maintenance capex. Growth capital expenditures are an option for businesses and should not be considered an operating cost. Even Warren Buffett has been promoting this idea for decades.

Against this background, the graph below shows Nvidia’s profit as a ratio to its EPS, which averages 174%. That said, its true earnings are 1.74 times its EPS because most of its capital expenditures are used to drive growth, which is not a necessary expense for the business and should not be considered a cost . Nvidia’s current profit-to-EPS ratio is 132%. So, with growth capex properly separated, Nvidia’s P/E ratio is only around 32, even lower than its previous non-GAAP of 37.

Valuations are more reasonable, but still high

The recent correction has brought Nvidia’s valuation back into a more reasonable range relative to its historical valuation and that of the broader market. As mentioned, Nvidia is currently trading at a price-to-earnings ratio of around 37 to 43, more than halved from a high of over 100.

But even after adjusting for the difference between book and true profits, Nvidia’s valuation remains high, both relative to the market and its peers . So far this year, the Nasdaq’s price-earnings ratio is around 34, and now it has fallen back to around 23. Compared with the Nasdaq, Nvidia’s stock price is still relatively high . It clearly trades at a premium compared to peers like AMD (around 35) and Intel (INTC.O) (less than 10).

Profitable prospects

Growth is Nvidia’s main attraction. Nvidia’s current earnings growth rate is vastly underestimated when considering future growth. Its current PEG (price-earnings ratio and earnings growth ratio) is only about 0.76 . The following figure is the data given by the financial website Seeking Alpha.

Granted, Nvidia’s PEG is still about 25% higher than its peer AMD in this regard, but it pales in comparison to the Nasdaq’s 3.4. Assuming Nasdaq’s annual earnings growth rate is 10%, Nvidia’s annual earnings growth rate may only be 1/4 to 1/5 of the Nasdaq.

But looking ahead, Nvidia still has a good card in its hands to boost earnings growth, with a slew of new products it is preparing to launch , such as the GeForce RTX 3050 desktop graphics card for gaming, the GeForce RTX 3080 graphics card and the GeForce RTX 3070 laptop graphics card.

Nvidia is likely to further expand its margins and drive profit growth as it continues to improve in the high-end gaming market. Nvidia’s data center is another segment with high growth potential. The data center division just released version 1.1 of Nvidia AI Enterprise. Gross margins are expected to be as high as 65% (GAAP basis) to 67% (non-GAAP basis) given the shift in the product mix to high-margin products.

Summary and some other risks

In addition to the high P/E ratio mentioned above, there are some other major risks. After considering and weighing the positives and negatives, Envision Research gave Nvidia a Neutral rating. Investors interested in buying should continue to wait and see.

In terms of macroeconomic risks, the likelihood of a recession has increased substantially over the past few quarters as high inflation and supply chain disruptions persist or even intensify. Nvidia’s high-end and high-margin products are particularly sensitive to this recession . This concern has also led several high-growth tech companies, including Meta Platforms, Netflix and Peloton, to announce in recent weeks that they will not hire new hires or even lay off workers, which could have a secondary adverse effect and dampen demand for Nvidia.

Nvidia’s products have considerable exposure to the cryptocurrency mining business. The cryptocurrency market has been very volatile and has just suffered huge losses in recent days, which may affect future demand for Nvidia products.

This article is reprinted from: https://news.futunn.com/post/15814254?src=3&report_type=market&report_id=206492&futusource=news_headline_list
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