Nvidia stock has been a standout performer in the AI boom, rising by over 180% year-to-date. However, could this remarkable run reverse, and the stock fall by over 50% from current levels? It’s a real possibility. At the current market price of $140, Nvidia trades at over 80x trailing earnings and 50x projected FY’25 earnings. These multiples seem elevated, but they sure are supported by the company’s recent high growth rates as Nvidia has been witnessing booming demand for its graphics processing units (GPUs), which have become the go-to silicon for artificial intelligence applications.
However, stock markets often extrapolate short-term trends into the long run. In Nvidia’s case, the price likely assumes that demand growth, pricing power, and profits for Nvidia’s accelerators will remain robust as the generative AI wave holds up. Yet, there are significant risks to this assumption, making a sizable correction a real possibility. The broader economic environment adds another layer of uncertainty. While markets have rallied following the election of Donald Trump, the risk of inflation persists amid threats of tariffs and deportation policies. These factors could impact the interest rate environment and, in turn, the valuation of high-growth stocks like Nvidia. (S&P To Crash More Than 40%?) We present this downside as a counter to our analysis of Nvidia’s upside to $300. Indeed we believe this broad range of upside and downside potential represents a simple fact: Nvidia is a volatile stock.
How Volatile Has Nvidia Stock Been?
While NVDA stock swelled over 10x from levels of $13 in early January 2021 to around $140 now, vs. an increase of about 50% for the S&P 500 over this roughly 4-year period. It was a bumpy ride, with returns for the stock being 125% in 2021, -50% in 2022, and 239% in 2023. The underperformance in NVDA’s stock vs. the S&P 500 in 2022 stands out in particular – as the benchmark index had returns of -19% that year, compared to a 50% drawdown for Nvidia. Notably, the Trefis High Quality Portfolio, with a collection of 30 stocks, has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics.
Nvidia’s Growth Rates Could Cool Off
Nvidia’s sales have grown at a breakneck pace. Nvidia’s revenues were up by close to 3x over the last 12 months as companies doubled down on accelerated computing using GPUs to perform more artificial intelligence tasks. However, there is a possibility that growth could cool considerably or potentially even flatline.
Why?
The underlying economics of the end market for GPU chips and the broader AI ecosystem are weak, and most of Nvidia’s customers remain loss-making. Large language models are very expensive to build and train. VC firm Sequoia estimated that the AI industry spent $50 billion on Nvidia chips last year, and the total could exceed $100 billion when including ancillary investments. Despite this, these investments have only generated about $3 billion in revenue, with few AI services besides ChatGPT gaining a large base of paying customers. We could very well be in a phase where companies are seeing so-called FOMO, compelling them to invest in AI just because their rivals are doing so, without a thought about the return on investments. As shareholders seek better returns, we could see capital spending cool off, impacting the likes of Nvidia. The macro environment might also play spoilsport. The Fed all but finalized last week that rates are unlikely to be cut in the Fed’s December meeting amid concerns about inflation. Elevated interest rates could further compound the weak payback equation for AI GPUs.
Separately, large AI deployments have two stages the compute-intensive training phase, which drives Nvidia’s current demand, and the deployment phase, where trained models are used in real-world applications with lower power requirements. Most companies are going through the compute-intensive training phase at the moment, and there’s a real possibility that demand for GPUs could cool off once these companies move to the deployment phase.
Even if demand for Nvidia’s products remains strong, growth could face challenges on account of supply constraints or execution issues. Nvidia has adopted a timeline of releasing a new AI chip series annually, which increases the risk of missteps. For instance, Nvidia’s latest Blackwell chip faced certain design flaws which delayed its release by a quarter. Although these issues were eventually resolved, a recent report by The Information indicates that the chip is now overheating when used with certain customized server racks. While Nvidia is reportedly working with its suppliers to redesign these racks to address the problem, the incident highlights the risks associated with Nvidia’s aggressive development schedule. Moreover, Nvidia relies almost entirely on Taiwan Semiconductor Manufacturing Company for GPU production. This dependency could introduce further bottlenecks, as TSMC’s production timelines may not align with Nvidia’s ambitions. While Nvidia aims to launch a new AI chip every year, TSMC requires at least 18 months to set up new manufacturing facilities, according to The Economist. A potential misalignment between Nvidia’s goals and TSMC’s production capabilities could constrain Nvidia’s ability to meet demand effectively.
Now Nvidia’s revenues are on track to more than double this year to about $126 billion per consensus estimates. However, if its growth rates slow considerably from here on to just about 15% over the next two years due to the aforementioned factors, sales could see a much more subdued move from around $61 billion in FY’24 to about $166 billion in FY’27.
Nvidia’s Margins Could Be At Risk
Nvidia’s margins (net income, or profits after all expenses and taxes, calculated as a percent of revenues) have been expanding – they grew from levels of about 25% in FY’19 to about 49% in FY’24 as the company witnessed better economies of scale and a more favorable product mix skewed toward complex data center products. Our dashboard has more details about the various components responsible for Nvidia’s net income change.
However, there is a real possibility that margins could decline to levels of about 35%. Why is that so? Competition is mounting with other chipmakers such as AMD investing significantly to catch up in this space given the high stakes. AMD claims that its new Instinct MI300X chip outperforms Nvidia’s current chips in several parameters, while Intel is also looking to make a dent in the space with more value-priced AI chips. Customers are also looking for alternatives to Nvidia, as they look to better manage costs. On Monday IBM said that it was collaborating with AMD to include Instinct MI300X accelerators into its cloud offerings. Separately, big tech players like Google – who are among the biggest buyers of Nvidia’s GPUs – are doubling down on their own AI and machine learning-related silicon. It’s quite likely that stronger competition will make Nvidia’s current revenue growth rates and abnormally high margins unsustainable.
How Does This Impact Nvidia’s Valuation?
If we combine 1.3x revenue growth (up 30%) between FY’25 and FY’27, with margins contracting from 50% levels currently to about 35% (down 30%, or 0.7x), this would imply that net income could decline by roughly 10% by 2027. Now if earnings shrink by 10%, the P/E multiple is also likely to take a hit as investors re-assess Nvidia’s long-term growth prospects. If Nvidia’s P/E gradually shrinks from a multiple of about 50x now to about 25x, this could translate into a decline in Nvidia stock by over 50% to levels of roughly $65 per share. What about the time horizon for this negative-return scenario? In practice, it won’t make much difference whether it takes two years or five years – if the competitive threat plays out and Nvidia’s GPU cash cow faces headwinds, we could see a sizable correction in Nvidia stock. (Should you Buy, Sell, Or Hold Nvidia Stock?) And it could be a bumpy ride yet again.
While there is certainly a case to be made for long-term gains from NVDA stock, the Trefis High Quality Portfolio could be right up your alley if consistent outperformance is at the top of your list.
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