Could Nvidia Stock Crash To $40?

Could Nvidia stock (NASDAQ:NVDA) fall to $40 in the next few years from the roughly $120 level it is at currently? Does this sound absolutely ridiculous?

Consider this – about a year ago, NVDA stock was trading at around $50, almost 60% below the current value. And less than 18 months ago at the end of March 2023, the stock was at just about $28! At the current market price of $117, Nvidia stock trades at about 70x trailing earnings and 46x projected FY’25 earnings. Are these multiples too high? Not if we consider the high growth rates the company has been seeing of late, driven by surging demand for its graphics processing units which have emerged as the defacto silicon for running artificial intelligence applications. 

That being said, stock markets are often myopic and tend to extrapolate short-term trends for the long run. In Nvidia’s case, the assumption is that demand growth and pricing power will hold up and profits will remain sizable as the generative AI wave advances. However, there are multiple risks and there remains a real possibility that the stock could see a sizable correction.  We present this 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.

Just how volatile has Nvidia stock been?

While NVDA stock swelled 900% from levels of $13 in early January 2021 to around $117 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. Notably, the Trefis High Quality (HQ) 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 Revenue growth 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, growth is slowly cooling off. Nvidia’s sales expanded by about 122% in the most recent quarter and growth rates are expected to fall to around 30% levels by next year, per consensus estimates. There is a possibility that growth could cool further 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.

Separately, large AI deployments have two stages:

1. the compute-intensive training phase, which drives Nvidia’s current demand;
2. 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 somehow remains strong, Nvidia’s growth rates could be constrained by its supply. Nvidia relies almost entirely on foundry major TSMC to produce its GPUs and there are signs that their product cycles are not exactly in sync. While Nvidia is targeting launching a new AI chip every year, TSMC apparently requires at least 18 months to set up a new factory, per The Economist.

Now Nvidia’s revenues are on track to roughly double this year to about $109 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 move from around $61 billion in FY’24 to just about $145 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 on an improving trajectory – 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? 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. Separately, big tech players like Google – who are Nvidia’s biggest customers – are doubling down on AI and machine learning-related silicon. 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 actually decline by about 10% by 2027. Now if earnings shrink by 10%, the P/E multiple is bound to take a hit as investors re-assess Nvidia’s position as a growth stock. If Nvidia’s P/E gradually shrinks from a multiple of about 46x now to about 20x, this could translate into a decline in Nvidia stock to about $45 per share. What about the time horizon for this negative-return scenario? In practice, it won’t make much difference whether it takes 2 years or 5 – if the competitive threat plays out and Nvidia’s GPU cash cow faces headwinds, we could see a correction. And a big one at that

And it could be a bumpy ride yet again. While there is certainly a case to be made for more long-term gains from NVDA stock, the Trefis High Quality (HQ) Portfolio could be right up your alley if consistent outperformance is at the top of your list.

[1] Returns as of 8/29/2024
[2] Cumulative total returns since the end of 2016

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