Nvidia (NASDAQ:NVDA) established itself as a powerhouse for software companies looking to tap into the exponential growth potential of AI and other high-growth technologies. Even better, year to date, the Nvidia stock has surged this year on strong earnings. In addition, Nvidia’s chips continue to hold a strong market share relative to competitors like Intel (NASDAQ:INTC) and Advanced Micro Devices (NASDAQ:AMD). And while I believe this dynamic will continue for some time, there are competitive pressures investors must be aware of.
With a market cap that recently crossed the trillion-dollar threshold, investors may now be asking how high Nvidia stock can fly. After all, trees don’t grow to the sky. So, here’s my take on why now may be a good time for investors to demonstrate caution when it comes to Nvidia stock.
Nvidia stock is Overvalued
Despite a 13% year-over-year revenue decline in the company’s fiscal first quarter of 2024 (to $7.19 billion), Nvidia’s appeal remains strong thanks to the AI hype. With projected revenue of $11 billion for the current quarter, the company and the market anticipate robust growth. However, this optimism may lead to potential disappointment.
Nvidia’s valuation appears stretched, with a high GAAP trailing-12-month price-earnings ratio of 195.6 times. That surpasses the sector median of 25.19 times by a very wide margin. In addition, Nvidia’s TTM price-book and price-sales ratios also significantly exceed their respective sector medians. Concerns about the company’s valuation are not unique to me, as analyst Benjamin Melman from Edmond de Rothschild Asset Management recently expressed caution and took profits on NVDA stock. Melman emphasized the lofty valuations in the AI tech sector and stated that further gains would warrant increased caution.
AI Hype is Temporary
Nvidia’s role is to provide the software that powers AI applications, similar to how their graphics processing technology fueled gaming. However, Nvidia does not create these applications and does not hold a monopoly at the operating system level, even if it were an applications company. Additionally, the company faces challenges in the AI cloud market due to the economic tensions between the US and China as highlighted by CEO Jensen Huang.
China’s pursuit of independent AI solutions poses long-term challenges for Nvidia, despite short-term gains. The market overlooks this concern as Nvidia emphasizes the AI inflection point. Analysts anticipate AI replacing white-collar jobs and driving productivity leaps within five years, reshaping the world.
Despite NVIDIA’s strong company profile, the current stock price may not be enticing. Caution is advised as there is a possibility of potential drawbacks. It is recommended to proceed with small, gradual investments over an extended duration, considering NVIDIA’s potential for sustained high valuation.
Investors had a positive outlook on Nvidia stock before, but now they should approach it with caution. In my view, conservative investors should wait for the stock to decline to $350 before considering a long position. While I anticipate growth in Nvidia and other AI-related companies, it’s important to acquire NVDA shares at a fair price. Therefore, owning a few shares is acceptable, provided they are purchased at a reasonable valuation.
On the date of publication, Chris MacDonald did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.