Fundamentally, the AI tech leader’s stock and its growth prospects are unchanged from last week when shares hit an all-time high.
Given the headlines about Nvidia (NVDA -6.68%) stock’s minor pullback, one would think the sky was falling. Shares of the artificial intelligence (AI) chip leader dropped 6.7% on Monday to close at $118.11. This was the third consecutive trading day that shares declined, bringing the total pullback to 12.9% since the stock closed at an all-time high of $135.58 last Tuesday. (The market was closed on Wednesday for the Juneteenth holiday.)
Nvidia stock’s pullback in perspective
Nvidia stock has merely given up its gains from less than the last two weeks. Shares on Monday closed at their highest level since Tuesday, June 14. Moreover, despite the pullback, the stock is still up 139% so far this year, 180% over the one-year period, and 519% over the last three years.
Stocks never go straight up forever. There will always be pullbacks of varying magnitudes. Given Nvidia stock’s rapid run-up, it’s no surprise some investors are taking some profits off the table.
Nvidia stock is not like Cisco Systems stock before the dot-com bubble burst
In April, I wrote about the main qualitative differences between Nvidia stock now and Cisco Systems stock before the dot-com bubble burst in 2000. That article was in response to a good number of articles comparing the two situations.
Now that Nvidia stock is pulling back, more of these Cisco-Nvidia type of comparisons are probably coming. This article delves into two key quantitative differences between the two situations.
Margins: Key quantitative difference No. 1
Cisco stock skyrocketed in the 1990s despite the company’s gross, operating, and profit margins steadily shrinking for many years. It’s no surprise that Cisco stock plummeted when the dot-com bubble burst because its rise was not supported by the company’s business performance.
A main reason for any company’s margins to decline is increased competition stemming from moats that are not sufficient to keep competitors at bay. Indeed, in its annual reports, Cisco attributed “continued pricing pressure seen from competitors in certain product areas” as a key reason for its gross margin decline from fiscal 1998 to fiscal 1999 and also from fiscal 1999 to fiscal 2000.
Now, let’s look at Nvidia’s stock and margin performances.
Nvidia stock’s surge has been supported by expanding margins. Granted, the company had a recent year-plus period where margins declined, but that was due to the macroeconomic environment, and its margins have since come roaring back. Over the long term, Nvidia’s margins have trended upward — and currently, they are at record highs.
Stock Valuation: Key quantitative difference No. 2
The PEG is a much better stock valuation metric than the more commonly used price-to-earnings (P/E) ratio because it takes a company’s earnings growth into account. A stock’s PEG is calculated by dividing its P/E ratio by the company’s earnings growth. For instance, if a stock’s P/E is 40 and a company’s earnings per share increased 40% over the last year, its PEG is 1.0. As a rough rule of thumb, a PEG of 1.0 indicates a stock is about fairly valued, while PEGs over 1.0 suggest a stock could be overvalued. That said, PEGs will vary considerably by industry and other factors.
Cisco’s stock was very overvalued for most of its trading history before the stock reached its all-time high in March 2000. Its valuation was particularly bloated in 1999, the year before its stock plunged. Its PEG was over 7.5 in early 1999, and then it had no PEG (which means that earnings or earnings growth were negative), and then its PEG surged above 9 very soon before the stock’s crash.
Nvidia’s current PEG is well under 1.0. What its really low PEG is telling us is that, collectively, the market expects that Nvidia’s near-term earnings growth will significantly slow. No doubt, it won’t be able up to keep up the torrid pace of its recent year-over-year earnings growth. That said, it seems to me that the market is underestimating Nvidia’s earnings growth potential.
Granted, Nvidia’s data center platform’s powerful growth will slow down. But AI is still in the early innings, so this AI-driven platform still has huge growth potential. Moreover, Nvidia is not a one-trick pony. Self-driving cars are coming — and when they fully arrive, Nvidia’s auto platform’s revenue and earnings should soar.
Despite all the headlines over many years proclaiming Nvidia stock being very overvalued, that’s just not been the case. At least not for more than relatively brief periods.
Nvidia stock’s pullback is not driven by fundamentals
The key thing for long-term investors to remember: Nothing has changed fundamentally for Nvidia since its stock hit an all-time high last week. The company’s long-term growth prospects and AI’s long-term growth prospects remain unchanged.