Nvidia: Valuation Models Don't Work As It Doesn't Make Widgets (Technical Analysis)

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Nvidia Corporation stock is extremely overvalued if we use traditional valuation models that are built to assume identifiable trends and predictable forecasts.The nature of Nvidia's business, as a ...

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(Technical Analysis)\n</h2>\n\n<h4 class=\"meta\">\n\n\n2024-05-29 05:06 GMT+8&nbsp;&nbsp;&nbsp;<a href=https://seekingalpha.com/article/4696085-nvidia-valuation-models-dont-work-as-it-doesnt-make-widgets-technical-analysis><strong>seekingalpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>Nvidia Corporation stock is extremely overvalued if we use traditional valuation models that are built to assume identifiable trends and predictable forecasts.The nature of Nvidia's business, as a ...</p>\n\n<a href=\"https://seekingalpha.com/article/4696085-nvidia-valuation-models-dont-work-as-it-doesnt-make-widgets-technical-analysis\">Source 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Sundry Photography If Nvidia Corporation (Nasdaq: NVDA) made and sold widgets, I’d tell you to sell short as many shares as your broker would allow. In that case, NVDA would be extremely—comically—overvalued. A widget is “an unnamed article considered for purposes of hypothetical example.” (Lately, the word has been applied to small special purpose software applications. I don’t care about those.) It’s critical that anybody trying to value NVDA stock recognize how vital this is. Statistical, econometric, and stock valuation models all rest on a shared foundation. They assume we’re forecasting widgets. Widgets, being educational-make-believe items, involve rational data for supply, demand, pricing, etc. Trends need not be stable. In fact, it’s better that they aren’t. This provides publishing and employment opportunities for professors and practitioners. You can’t make money predicting the obvious. There are limits. If inputs are too weird, models can’t work. If you’re psychic and can see into the future, there’d be no problem. But if you’re human, you’d have a dilemma. You’d face two choices.  Admit you can’t predict, and search for another solution to the problem at hand. Use the data you have as best you can and try to explain such that your readers, clients, etc. won’t realize your work is bogus.  Everyone I’ve seen who tries to value Nvidia is using Choice 2. Some do so cynically. But to their credit, most do so unwittingly. Many don’t fully understand the shortcomings of their models or frameworks. I’m going to pursue Choice 1 here. I’ll start by pointing out how un-widget-like Nvidia’s business is. Then, I’ll show you how messy things get when we set out to use established valuation methods. The Un-Widget-Like Nature of Nvidia Unless you just woke up from a multi-decade nap, you probably know Nvidia is the AI (Artificial Intelligence) leader. You also know AI is exploding upward in terms of adoption and use. The Financial Times Lex column explains Nvidia could be the most valuable stock in the U.S. because of this. On Seeking Alpha, Bold Investor does a terrific job of explaining \"How Nvidia Is Leaving Competitors In The Dust.\" So, too, does Amrita Roy, in Nvidia: Upside Remains With Growing Data Center Revenue and Demand For H200 and Blackwell Chips. And certainly, keep checking the Seeking Alpha NVDA Summary page for more news and analysis. But don’t read passively. As you go through this content, and anything else you find, keep asking yourself… Is any of this even remotely “normal?” Take a look at recent revenue and EPS trends. Author's compilation based on Seeking Alpha Estimates presentationAuthor's compilation based on Seeking Alpha Estimates presentation The trends become even more stark when we look at some of the year-to-year changes in percentage terms. Author's calculations based on data from Seeking Alpha Estimates presentationAuthor's calculations based on data from Seeking Alpha Estimates presentation So, how comfortable would you feel making a numerical prediction about Nvidia’s future? In fact, how comfortable might you be in “predicting” NVDA’s past? Did you remember that earnings in the fiscal year that ended January 2023 were down? I couldn’t blame you if you didn’t. The 10K filed in February 2023 (just after the end of that fiscal year) said what it had to. Buried in the “Recent Developments, Future Objectives and Challenges” section on pages 36-39, we have such necessary recitations as…  Our supply, which includes inventory on hand, purchase obligations and prepaid supply agreements, has grown significantly due to current supply chain conditions, complexity of our products, and recent reductions in demand. * * * * Product transitions are complex as we often ship both new and legacy architecture products simultaneously and we and our channel partners prepare to ship and support new products. We are currently transitioning the architecture of our Data Center, Professional Visualization, and Gaming products. * * * * Gross margin for fiscal year 2023 declined from a year ago, driven by $2.17 billion of inventory charges largely relating to excess supply of NVIDIA Ampere architecture Gaming and Data Center products as compared to the demand expectations for these products, particularly for the expected demand in China. The inventory charges were comprised of $1.04 billion for inventory on hand and $1.13 billion for inventory purchase obligations in excess of our demand expectations.  More likely, investors focused instead on media reports with headlines such as “Nvidia soars 14% as analysts praise gaming and guidance led by generative AI” from February 23, 2023. I get it. The world and the company are changing. We don’t want to lock too hard on the past. But numerical models need the past. Without establishing solid relationships between old numbers and old outcomes, there’s no way they can translate new expectations into new numbers So we’re really left only with qualitative, verbal predictions. We can say, stupendous, astronomical, massive, breathtaking, unprecedented, etc. I wouldn’t argue with any of that. Consider, too, how Nvidia is approaching AI growth. Today, its Hooper H200 chips are the latest and greatest. But that’s about to be supplanted by its new Blackwell offering. It will be five times faster in AI “training” (teaching AI how to do its thing). And it will be 30 times faster in AI “inference” (AI applying what it learned and tackling tasks on its own). And still, Nvidia is going to keep on going. During the May 2024 earnings call, an analyst wondered how customers who bought a recent offering will react to those being so quickly supplanted. In response, CEO Jensen Huang said: [W]hen Blackwell comes, it's going to be terrific. And then after Blackwell, as you mentioned, we have other Blackwells coming. And then there's a short -- we're in a one-year rhythm as we've explained to the world. And we want our customers to see our road map for as far as they like, but they're early in their build-out anyways and so they had to just keep on building, okay. And so there's going to be a whole bunch of chips coming at them, and they just got to keep on building and just, if you will, performance average your way into it. And customers won’t stand pat. Huang expects them to run forward as Nvidia keeps enabling them to do so. And so the question is, do you want to be repeatedly the company delivering groundbreaking AI or the company delivering 0.3% better? That's the reason why this race, as in all technology races, the race is so important. And you're seeing this race across multiple companies because this is so vital to have technology leadership, for companies to trust the leadership and want to build on your platform and know that the platform that they're building on is going to get better and better. For us, as outside investors trying to make sense of Nvidia’s stock price, this poses a monstrous challenge. Without giving away numbers, Huang is suggesting that Nvidia is not going to return to any sort of widget-like normalcy any time soon. In fact, even if Huang wanted to say anything beyond “terrific,” I doubt he’d be able to. Nvidia’s insiders have a lot more information than we have. They talk to customers. They know what they’re working on, and see orders before they progress to reportable revenues. Likewise, they know what new orders are likely in the pipeline. Information like this is used by companies to come up with analyst guidance. Don’t use revenue/EPS surprise as a cue to how effective a company is at predicting its own results. Databases report surprise based on how reported numbers compare with the most recent estimates. We need to look at revisions. These numbers reflect company adjustments (revised guidance) that correct prior forecast errors. Look now at the record of quarterly estimate revisions over the past six months. Seeking Alpha Estimate Revisions presentationSeeking Alpha Estimate Revisions presentation Bear in mind, Nvidia is a fundamentally and financially powerful company. Author's computations and summary from data displayed in Seeking Alpha Portfolios If there were a tool, a model, a consultant or whatever that could help it better forecast its own results, and give better guidance, Nvidia could easily afford to sign up for it. I assume it didn’t because it doesn’t exist. The Two Established Valuation Approaches Are Useless If you’ve been following or reading about stocks for a while, you’ve likely seen many valuation approaches. The Seeking Alpha Valuation Grade uses 19 ratios. All of these, and any like them, you might imagine, are in the relative valuation family. Here, we compare a stock’s ratio to those of others. Usually, it’s a peer group. (Seeing Alpha publishes sector medians). Some, including Seeking Alpha, also compare a company’s current ratio to a historical figure. The other approach is absolute valuation. Here, we look only at the company and try to figure out what it’s really worth, an intrinsic or fair value. We do this by estimating the money you expect to get from owning shares (and comparing that to the current price). You may have seen this referred to by its fancier business-school label… discounted cash flow (DCF). You might also have heard about something you’re led to believe is a third approach… asset valuation. Supposedly, this tries to determine the price an acquirer would pay to purchase a company. Don’t fret about asset valuation. It’s mostly the same as the other approaches, relative or absolute value. But this time, you’re imagining yourself as a potential acquirer. Even as such, you’d still do a relative or absolute valuation exercise. It differs only insofar as you imagine an acquirer would make different forecasts and/or would add in a control premium. (One who is in control can get the business to meet a different set of forecasts.) Good luck to any would be acquirer who thinks it can run Nvidia better than can its incumbent management! Let’s just stick with relative and absolute valuation. Nvidia’s Relative Valuation Seeking Alpha’s valuation grade for Nvidia is “F.” That’s as bad as it gets. Looking at the table below, we can see, even without knowing Seeking Alpha’s secret sauce, that the relative valuation cannot come close to justifying anything close to Nvidia’s current price. It can’t even sniff the low end of what a reasonable observer would call a price range. Author's computations and summary from data displayed in Seeking Alpha Portfolios I do point out that high ratios are OK if warranted by expected future growth rates and/or margin expansion. After we cover absolute valuation, I’m sure you’ll agree there’s nothing we can rationally do on that front to rescue Nvidia’s relative valuation. Nvidia’s Absolute Valuation In theory, I could write a book about this huge topic. But I won’t. Seeking Alpha contributor Professor Aswath Damodaran has already published several excellent works on this topic. I wouldn’t dare try to outdo him. Instead, to deal with Nvidia, we can dramatically simplify. I’ll use something every finance major probably has seen. It’s the Gordon Dividend Discount Model (DDM). It tells us a stock is worth the present value of all dividends we expect to receive, plus the present value of the eventual price at which we’ll sell. There are two challenges… one mathematical and one practical. The mathematical challenge is that we have no idea when we’re going to sell. We could, say, assume five years out and do another valuation as of then. But we’d have to then figure out when our hypothetical buyer will sell. And then, when would the next buyer sell? And so on. To avoid something like an endless loop, we assume we’ll hold until infinity. That lets us use some simple math (simple to us, but not to the folks who came up with it). Essentially, Price (P) equals the next Dividend ((D)) divided by the difference between the required rate of return ((R)) and the expected infinite rate of dividend growth (G). It’s… D = P (R – G) Now for the practical challenge. Many investors, including many Seeking Alpha regulars, want and care about dividends. But many more don’t. In fact, so many don’t care about dividends, I think we can, as a practical matter, substitute E (Earnings) for dividends. (And now, G refers to the earnings growth rate). Obviously, D and E aren’t equal. Some earnings are paid out as dividends. The rest is retained for company is (reinvestment in the business, or even share repurchases). But for all practical purposes, today’s investment culture is such, that for most stocks, and especially stocks like Nvidia, investors are content to act as if shareholders said “no” to dividends and told the company to reinvest everything. That gives us a revised absolute value formula. Now it’s P = E / (R – G) This looks a lot simpler than any DCF model you’ve likely seen. And with the sort of reshuffling that’ll bring back middle-school memories, we can divide both sides of that equation by E. P/E = 1 / (R – G) We’ve seen that before… or at least the left side. It’s the P/E ratio! (We can even do this with S, Sales. All we need to do is substitute Sales times margin ((M)) in place of Earnings: P = (S * M) / (R – G) and P/S = M / (R – G).) Let’s do a quick exercise with Nvidia. For R, I’ll start with the 10-year treasury (US10Y) as a risk-free rate of return. That, now, is 4.47%. Based on the capital asset pricing model, I’m going to increase that by an assumed equity risk premium (I’ll say 5%) multiplied by Nvidia’s Beta (I’ll use 1.75, which Seeking Alpha reports as the 60-month computation.) That means I’ll add 8.75% (5% times 1.75) to the risk-free rate. So R, the required rate of annual return for valuation purposes, is 13.22%. I suspect you’re tempted to argue. Why did I use a 10-year Treasury rate instead of a different one? How did I get 5% as an equity risk premium? Why didn’t I use Seeking Alpha’s 24-month beta (1.88), or a figure calculated over a different period? We already have three legitimate debating points. And we haven’t yet gotten to the good part. Let’s go there now. What on earth are we going to do about G? I’ll bet you’re tempted to open Seeking Alpha’s Growth report for Nvidia. Among lots of other interesting numbers, you’ll find there the consensus analyst “EPS FWD Long-Term Growth (3-5Y CAGR).” For Nvidia, this is 37.78%. OK. We’ve got it. Let’s forecast a fair price. (For E, I’m going to use the analyst consensus estimate of current-year EPS, which is $27.33.) P = E /(R – G) applied to Nvidia is P = 27.33 / (13.22% - 37.78%), which gives us… Whoops! We have to divide 27.33 by minus 24.56%. That would put the fair price at about minus 111. That can’t be right! It isn’t. Here’s the catch… We weren’t supposed to set G equal to 37.78%. That, as seeking Alpha tells us, is an expected 3- to 5-year growth rate. We’re looking for an infinite growth rate. No company can ever be expected to grow like that all the way to infinity. If we’re looking out to (and mathematically speaking, I suppose) beyond the end of the world, we need to assume an extremely mature company. Many who assume the world won’t end use something like 2%-3%, based on assumed infinite population growth plus, perhaps, a bit extra for improved productivity. I’ll go with 3%. Now, I can compute a fair price. It’s 27.33 / (13.22% - 3%). That works out to about $267. Because Nvidia today trades above $1,000, we have to say it fails the intrinsic value test with flying colors. I can’t even use the 37.78% growth estimate to rescue Nvidia’s failed relative valuation. The footnote to the above table mentioned that a higher growth rate would support a high P/E. So let’s try that… P/E = 1 / (R – G). I know you already see what’s coming. Setting G to 37.78% would give us a negative P/E. We could use the 3% assumed infinite growth rate. But seriously… Would you invest real money based on that! You might say DDM is too simplistic. You might wonder about a more substantial DCF model. Analysts do that all the time. But scrutinize them very, very closely. A correct DCF will have a DDM-like computation using an infinite growth rate at the end. It may be five years out. It may be 10 years out. It may be 20 years out. But it will be there. You can’t do DCF without it. And this so-called “terminal value” typically comprises a large portion of the final valuation. Back to my original point. These models are great for widgets. However, for Nvidia…. No way. So, consistent with what I wrote above, let’s admit we “can’t predict and search for another solution to the problem at hand.” Another Solution – The Keynesian Beauty Contest I introduced this in my May 21, 2024, Carvana (CVNA) article. And I’m shocked that it gets so little attention. This behavioral finance concept is the only thing that supports charting and technical analysis as an important discipline. Here’s how I described it…  Imagine you’re a beauty contest judge. You know which contestant you prefer. But that’s not relevant here. You’re supposed to pick the contestant you believe will be preferred by most other judges. I know what I think of CVNA. I like this investment opportunity. But Wall Street is really a Keynesian Beauty Contest. So, I can’t necessarily buy or hold based on just my opinion. I have to decide how I think other investors will evaluate CVNA. This is where chart reading can be very helpful. And it’s why as much of a fundamentals-story guy as I am, I still respect technical analysis. (But I don’t go crazy trying to have the biggest fanciest set of indicators. Many give duplicate messages anyway. So, I keep it simple.)  That, really, is the only rational way we can evaluate Nvidia’s stock. Stretching the logic, we wouldn’t really be zeroing in on the stock. We’d be evaluating how the other Keynesian judges are assessing the probable vigor and growth of Nvidia’s AI profitability. (The stock will follow along.) This seems a bit like a \"wisdom of the crowd\" approach. But I want to stop short of that. We really don’t know if the crowd is being wise or dumb regarding Nvidia. All we need to know is what the crowd is doing with its money based on its opinion, whether wise or dumb. We won’t try to second guess the crowd. We’ll just follow the money. When the crowd is hot, we buy. When it cools, we sell. And, when we can’t decide one way or another, we stay neutral (OUT) or, perhaps, use an Nvidia-holding ETF to diversify away a big chunk of our risk If you can interpret charts on your own, go for it, use any technical analysis approach you wish. Or, you can consult any technical analysis writer or source you like. Risks Do you have a few hundred hours to spare for this topic? Just kidding. Under the framework I presented here, the risk is quite straightforward. It’s the possibility that one’s assessment of how other market participants (Keynesian judges) feel about Nvidia is wrong. Notice… I’m not pinning the risk on whether the others are actually right or wrong. It’s about the accuracy of your (or in this case, my) assessment of how they feel. What To Do About Nvidia Stock I’m not a technical analysis expert, so I cloak my opinion with a heavy coating of humility. (And I won’t own Nvidia directly unless I’m highly confident in the conclusions I draw from the chart.) But I do have some sense of the field. So here goes. StockCharts.com I love how the 10-day exponential moving average (EMA), after having slumped mildly below the 50-day EMA pre-earnings release, is now off to the races. The Chaikin Money Flow (CMF) and the Chaikin Oscillator (CO) measure which party to trades is more motivated. CMF does it for institutional investors. CO does it for the market in general. Both indicators are strong and rising. Buyers really, really want to get their hands on stock. But sellers are less motivated to sell. That’s exerting upward pressure on Nvidia’s stock price. The Keynesian judicial bench favors the bulls. As I’ve said before, my investment stance depends mainly on whether I think a stock will be better than, in line with, or worse than the market. Here’s how I apply that to the Seeking Alpha rating system:  “Strong Buy” means I see the stock as being better than the market, and I’m bullish about the direction of the market. “Buy” means I see the stock as being better than the market, but am not confident about the market’s near-term direction. “Hold” means I see the stock as moving in line with the market. “Sell” means I see the stock as being worse than the market, but am not confident about the market’s near-term direction. “Strong Sell” means I see the stock as being worse than the market, and I’m bearish about the direction of the market.   Being a long-time fundamentals guy with an affinity for value, I approached this article expecting to come out neutral. But based on this scale, and what I can’t deny seeing, I’m rating Nvidia as a \"Buy.\"","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.24.2","shortVersion":"4.24.2","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2439393045"}