KEY POINTS
- Nvidia is arguably the leading semiconductor stock right now.
- It has not escaped the recent downturn among tech stocks.
- Despite its dependence on production facilities in a potentially dangerous region, the stock does not trade at a discount.
Nvidia is considered by some to be the world's leading semiconductor company. Its GPUs power applications in artificial intelligence, virtual reality, and data centers, and its massive growth has sent the stock price to record highs. Its technical lead should help keep it a long-term winner for some time to come.
But all those positives have not helped Nvidia escape the sell-off in tech stocks, and its stock price has dropped more than some of its mega-tech counterparts. Amid this drop, investors may want to consider putting off additional purchases of thechip stockfor one critical but overlooked reason.
The state of Nvidia
Currently, Nvidia sells for a P/E ratio of around 60. This multiple is low compared to some growth-oriented tech stocks trading today. It might also seem reasonable considering that in fiscal 2022, revenue climbed 61% year over year to $26.9 billion. Also, during the same period, net income of $9.8 billion increased by 125%.
Aside from the triple-digit income growth, the stock price increased by nearly 740% over the last five years, around eight times as much growth as the S&P 500 over that time.
Unfortunately for Nvidia investors, the stock has become a victim of the overall economic environment. It has not experienced the approximate 60% decline that has hit growth tech funds such as the Ark Innovation ETF. Still, like its rival, $AMD(AMD)$ , Nvidia has experienced a stock price drop of almost 35%. This does not compare well to $Apple(AAPL)$ , which experienced a more modest 15% correction.
Still, Apple sells for a P/E ratio of just over 25, which may explain the more muted decline. Also, with tech stock prices falling, investors are less likely to buy any stock at a premium, even one that produces strong results like Nvidia.
An overlooked danger for Nvidia
Moreover, Nvidia has becomedisconnected from realityin terms of its overlooked political risk. Nvidia is fabless, meaning its chip fabrication depends on outsourcing manufacturing to East Asia, a region with more than its share of political tension these days.
Much of this risk revolves around the primary foundries it depends on to produce its chips, the largest of which is $Taiwan Semiconductor Manufacturing(TSM)$ . Because the company produces most of its chips in Taiwan, TSMC effectively puts Nvidia in the middle of Taiwan's tensions with China. Because China needs Nvidia's semiconductors just like every other country does right now, it could act as a deterrent to an escalation in hostilities. Still, the situation should concern Nvidia stockholders since Taiwan has been under threat of Chinese invasion for decades.
Furthermore, in the foundry industry, TSMC holds the technical lead and produces just over half of the world's chips, according to TrendForce. This strongly links Nvidia's fortunes to TSMC's prosperity.
Investors should also note that TSMC's stock has not escaped this political risk. Despite the severe chip shortage, TSMC has not sold for more than 40 times earnings in recent years. Also, even with a technical lead, it currently trades at a 25 P/E ratio.
Furthermore, Nvidia's other primary foundry, Samsung, faces similar political dangers with its South Korea-based foundries. This risk and TSMC's lower multiple could lead investors to question the wisdom of paying a premium for Nvidia when it effectively faces the same political risks as its primary foundries.
Trading Nvidia amid the political risk
Nvidia's technical lead and massive revenue growth should mean that the stock beats the S&P 500 over time. However, investors should consider holding out for a much lower valuation.
With almost all tech stocks falling, stockholders should not expect it to buck overall market trends. Moreover, most of its chip production occurs in a region dealing with geopolitical tensions. This probably means that if TSMC deserves to trade at a discount, so does Nvidia.
source: TMF
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