1 Flashing Warning Sign in Nvidia’s Stock That You Shouldn’t Ignore

Nvidia (NVDA 0.06%) shareholders have had a fantastic start to the year — the stock is up 89% since the calendar flipped to 2023. However, the party could be ending soon.

Even though the stock price is still 17% below its all-time high, Nvidia’s valuation at levels last reached during 2021 — a time when the company was firing on all cylinders (Nvidia’s revenue grew by over 40% for nearly two years straight). Nvidia has posted negative revenue growth the past two quarters, far from its 2021 performance. As such, shareholders should be cautious, as the stock looks highly overvalued.

Gaming revenue has fallen

Nvidia’s primary products are graphics processing units (GPUs), which are utilized to conduct particularly intense calculations. While GPUs were initially used (as their name implies) to provide the processing power needed to produce complex computer graphics, largely for video games, a host of other use cases for them have since been discovered. For example, GPUs are well suited to the demands of processing engineering simulations, powering supercomputers in data centers, and mining cryptocurrencies. It was that last use case that led to its most recent downturn.

After the tech bubble burst in late 2021, setting off a year-long decline, the price of leading cryptocurrency Bitcoin (CRYPTO: BTC) fell, as did Nvidia’s stock. While these two things happened in parallel, neither slide exactly caused the other one. But what happened next to Nvidia clearly had its roots in the crypto situation.

With a low Bitcoin price, cryptocurrency mining operations became unprofitable as input costs exceeded the outputs. This caused many miners to turn off their rigs. Some chose to sell some of their GPUs, flooding the market with thousands of high-powered secondhand GPUs. This softened the new GPU market and caused sales in Nvidia’s gaming division to collapse. (The GPUs utilized for gaming platforms are the same as those used by cryptocurrency miners.)

Additionally, the second-most popular cryptocurrency, Ethereum, switched to a proof of stake model in 2022, which doesn’t require mining anymore. Without the need to mine Ethereum, crypto miners either shut off and sold their rigs or switched to mining other coins — further exaggerating the GPU supply glut.

Additionally, many people built gaming rigs during the pandemic’s lockdown phases, and those with recently upgraded hardware would have felt less of a need to upgrade their systems again so soon. In Nvidia’s fiscal 2023 fourth quarter, which ended Jan. 29, its gaming segment revenue fell 46% year over year — a noteworthy collapse. 

Furthermore, while crypto markets have been recovering somewhat in 2023, investors have no evidence that Nvidia is seeing a demand boost related to that. So while much of Nvidia’s stock movement reflects that investors are anticipating a recovery, there’s another factor at play here: artificial intelligence (AI).

Related articles

No, Russia did not just lift its ban on domestic crypto use

30 July 2024

New US Bitcoin Mining Hardware Creates $20B Opportunity, Could Disrupt China’s Mining Dominance: Bernstein – Canaan (NASDAQ:CAN)

30 July 2024

AI hype has taken over

Artificial intelligence has been a hot topic on Wall Street ever since ChatGPT took the world by storm late last year. Nvidia has been a primary benefactor of that surge in interest, as its GPUs are used to train and power AI models. The chipmaker has been up front with investors for a long time about the tailwinds this industry could provide, but only now are investors starting to pay attention.

Unfortunately, now there’s too much AI-related hype around the stock, as one quarter of growing interest in AI isn’t going to translate into rapid meaningful business gains for Nvidia. AI will be a long-term tailwind, and it’s one of the reasons I own the stock. However, with the valuation out of control, the stock looks dangerous.

Just look at its price-to-sales ratio; it’s nearing the elevated valuations last seen during 2021.

NVDA PS Ratio data by YCharts.

Some might say this is an unfair comparison as its gaming revenues are down, which inflates its price-to-sales valuation. But even if the stock were measured against Nvidia’s peak sales before last year’s collapse, it would be trading at 24.5 times sales.

ADVERTISEMENT

It’s not worth looking at Nvidia’s price-to-earnings ratio (it’s at 154), as that metric is heavily skewed because the company isn’t optimized for profits, likewise due to the gaming division’s weakness.

With the stock trading essentially on hype thanks to AI and a crypto recovery, shareholders must be on high alert. Unless Nvidia reports a blowout fiscal first quarter, the stock will likely fall in the wake of the next report, as it must achieve perfection to justify its current valuation.

Because of that, I’d advise investors to avoid buying this stock until its valuation reaches a more reasonable level. Of course, if you’re already a shareholder (like myself), selling now because of valuation would be a mistake, as Nvidia’s tailwinds are still blowing strongly. But, if the stock has become an outsized position in your portfolio, I think it would prudent to lock in some of your gains after its fantastic start to 2023.

Nvidia’s stock is extremely expensive. There are much better bargains out there, and you should look at those stocks first.