While Nvidia’s ($NVIDIA Corp(NVDA)$) executives might be celebrating this earnings season, many professional investors have many reasons to give pause. Central to this is the contention that the company’s outlook versus that of the stock is increasingly divorced.
The Good: Solid Earnings and a Shift in Consumer Mix
Key line items are examined with a "first-order" matrix to inspect their year-on-year change as well as a "second-order" matrix to winnow out sustained growth trends. The conclusions therein are singularly interesting:
After Fiscal Year (FY) 2022, there has been explosive change in the largely-orderly shifts in trends. In the present FY:
Revenue growth outpaces cost of revenue threefold while cost of operations increases a paltry 2%
Gross Profit and Net Income have shaken off the slumps seen in the previous FY to exhibit a massive outperformance well exceeding that of revenue-related trends, while the Gross Margin shows a 30% improvement over the previous FY at 73.8%
Inventories are only up 2% while a massive pileup in Accounts Receivable pushes current assets to 5-year highs
Net Income Per Share (or diluted EPS) has shown the biggest outperformance over all other trends with a nearly 700% markup relative to the previous FY.
The second-order trends, however, indicate how singular this moment is from historical trends. Virtually no single line item shows a sustained growth trend in any way, shape or form.
The company's products had long been favoured by the gamer and crypto miner. Over the past couple of years, however, the consumer mix has decidedly shifted towards the "corporate".
The data center segment registered a 217% first-order change to $47.5 billion, with numerous enterprise solutions in language models, generative AI and medical applications.
Language models and generative AI are writ large on its next biggest segment - Gaming - which delivered $10.4 billion this year (15% first-order change), with the bulk attributable to increasing inroads with game developers.
The second-largest first-order change (21%) and the smallest revenue contributor ($1.1 billion) was the automotive segment, with increased adoption by Chinese carmakers Great Wall Motors and Li Auto lying square and center.
The company's massive boost in earnings, however, doesn't translate to a massive dividend bonus for long-term investors. With dividends staying at $0.04, the yield is at the 0.02% mark. The company spent $9.5 billion in stock repurchases over the year – nearly identical to the $10 billion spent in the previous FY.
The Mixed: Nvidia isn’t the Most Valued Chip Stock
The semiconductor industry has been a substantial recipient of investor attention over the past couple of years, with "AI" being a dominant theme therein. The performance of a pool of 120 semiconductor/chipmaking-related stocks (which includes the company) depict this in stark terms.
Up until Q4 2022, market participants were fairly measured in their outlook for this sector. Despite Q1 2023 being a relatively bad period for stock performance, investor vigour contributed to a doubling of the Price-to-Earnings (PE) Ratios over the previous quarter. Barring a slight adjustment upwards in the next two quarters, massive net income accruals in Q4 2023 pushed the sector's PE aggregate to a twelvefold of its value a year prior.
The company's position within this sector, however, is mixed. As of the day before the earnings release, NVIDIA ranked:
10th in PE Ratio. California-based "fabless" chipmaker SiTime Corporation ( $SiTime Corp(SITM)$) ranked 1st.
5th in Price to Sales (PS) Ratio. Canada-based chip-scale photonic solutions provider Poet Technologies (Canadian ticker: PTK) ranked 1st.
5th in Price to Cashflow (PCF) Ratio. California-based semiconductor fabrication support specialist Ultra Clean Holdings, Inc ($Ultra Clean(UCTT)$) ranked 1st.
The Bad (?): It’s Time to Rationalize
As the company’s consumer mix changed over 2023, so did the company's PE Ratio.
As of the day before the earnings release, the PS Ratio was down 38% from a high of 45.5 while the PE Ratio was down 74% from a high of 222.
Traded volume was generally in the 45-65 million range except during options expiry/rollover and earnings release. When overlaid against the put-call interest ratio, the stock shows increasingly strong evenness in outlook. Through most of 2023, market participants were predominantly bearish on their outlook of stock valuation. In the current year, however, they have trended towards a ratio of 1.
As the PE Ratio rationalized, the Put-Call Ratio stabilized. Recent trends indicate that there is still a downward push on rationalizing the PE Ratio further.
The company predominantly operates as a designer while the bulk of the manufacturing/assembly of disparate components is carried out by Taiwan-based TSMC. Given that there is no single correct “architecture” and design is highly dependent on application, the company's "high water mark" currently achieved via successful corporate outreach and collaborations comes with the caveat that its counterparts will constantly look towards optimizing cost and performance based on need.
Another factor is the problem with the "Magnificent Seven", which has become a refuge for hype-driven investors. Economist David Rosenberg contends that the Magnificent Seven's frequent comparison with the dot-com stocks at the turn of the century is incorrect since the former are actually profitable. Instead, they should be compared with the American "Nifty Fifty" of the 1960s and 1970s (not to be confused with the Indian index) which were also mostly profitable. While the "Nifty Fifty" eventually tumbled over 60% between 1973 and 1975, most of the companies therein remained profitable all the way till the present. Much like the "Nifty Fifty" of yore, the Magnificent Seven is the dominant driver of today’s market.
Much like the "Nifty Fifty", a rationalization is due.
In Conclusion
As a company, the company's high earnings will likely stabilize on a forward-looking basis: corporate adhesion tends to be stable albeit and subject to significant interplay with requirement scoping and cost. A diverse set of corporate-centric hardware solutions can also be expected in the year to come.
As a stock, however, historically high ratio premia cannot be expected. Goldman Sachs reported2 that nearly every one of the 722 hedge funds surveyed with a total equity exposure of $2.6 trillion have been paring down their exposure to these stocks. A further 40-50% correction of the PE Ratio from the present level to the mid-twenties to early-thirties is likely on the cards while stock repurchases are likely to continue.
For broader articles that deep-dives into business and culture in Asia, visit asianomics.substack.com. Recent articles include an examination of rising numbers of Chinese residents buying homes in the U.S. made for Fox Business, an outline of stablecoins’ potential to transform the global FX market made for CoinDesk, and a recent op-ed made to CoinTelegraph.
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