How Nvidia Stock Could Drop 50%

Could Nvidia stock (NASDAQ:NVDA) fall by about 50% to levels of around $65 in the near term from the roughly $130 level it is at currently?  We believe this is a real possibility. Nvidia has seen its business boom, led by the surging demand for its graphics processing units which have emerged as the de facto silicon for running artificial intelligence applications. However, there are multiple risks on the horizon. These include a potential cooling of AI training-related demand, mounting competition, and less attractive valuation multiples assigned by investors, due to slowing growth and less favorable monetary policy. We spell out the key risks for Nvidia in more detail and break down how the stock could fall by over 50% from current levels by looking at three metrics, namely the company’s revenue growth, margins, and price-to-earnings multiple.  See our counter scenario on Nvidia Stock upside to $300. Indeed, we believe this broad range of upside and downside potential represents a simple fact, that Nvidia is a pretty volatile stock. While AI has been all the rage, quantum computing could be the next big thing. See What’s Driving D-Wave Quantum Stock?

Why Revenues Could Face Pressure

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. There remains a possibility that growth could cool further with sales potentially even declining versus current levels in the medium term. Here’s why.

Model training could ease on diminishing returns, focus on ROI

Companies have devoted immense resources to building AI models over the last two years or so. Now training these massive models is more of a one-time affair that requires considerable computing power and Nvidia has been the biggest beneficiary of this, as its GPUs are regarded as the fastest and most efficient for these tasks.  However, the AI landscape may be shifting. Incremental performance gains are expected to diminish as models grow larger in terms of several parameters. Separately, the availability of high-quality data for training models is likely to become a bottleneck as much of the Internet’s high-quality data is already run through large language models. Considering this, the considerably front-loaded AI training phase could wind down. The underlying economics of the end market for GPU chips and the broader AI ecosystem are weak, and most of Nvidia’s customers likely aren’t generating meaningful returns on their investments yet. As shareholders eventually seek better returns, we could see capital spending on GPU chips cool off, impacting the likes of Nvidia. Separately, if you want upside with a smoother ride than an individual stock, consider the High Quality portfolio, which has outperformed the S&P, and clocked >91% returns since inception.

Nvidia’s GPUs overkill for inference?

The long-term focus of AI will be on inference, where trained models are used in real-world applications. This phase is less computationally intensive and could open the door for alternative AI processors that are less powerful. To be sure, Nvidia may well remain the leader by far in inferencing as well, but there’s certainly an opening for rivals such as AMD and potentially even Intel to gain market share with chips such as AMD’s MI300 chips or Intel’s Gaudi AI accelerators. Nvidia’s top-end chips such as the H100 might be considered as overkill for simpler inference tasks, considering their high power consumption and upfront cost.

Better supply-demand equation

There are signs that the big supply-demand mismatch seen through the early phase of the generative AI wave is easing. Microsoft (NASDAQ:MSFT) which is Nvidia’s largest customer for GPUs, recently indicated that it was no longer supply-constrained for GPUs. The fact that Nvidia’s largest customer has sufficient chips to run its AI efforts suggests that the frantic “fear-of-missing-out” phase of GPU demand may be well behind us. Moreover, if demand stabilizes due to the above factors just as supply catches up, Nvidia may face pricing pressures or slower sales growth particularly if large customers rethink their inventory requirements.

Now Nvidia’s revenues are on track to more than double this year (FY’25) to about $129 billion per consensus estimates. However, if its growth rates slow considerably from here on to just about 10% over the next two years, due to the factors above, revenue could move from around $61 billion in FY’24 to just about $165 billion in FY’27.

Margin Pressures

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. Earlier this month, Amazon announced plans to build an AI ultracluster, essentially a massive AI supercomputer that will be built using its proprietary Trainium chipsets. Amazon is also marketing its AI products to other companies. For instance, Apple says that it uses Amazon’s AI chips for certain tasks such as searching. This could also pose a risk to Nvidia’s business and margins. Should you Sell Nvidia and buy Intel Stock?

The gains from NVDA stock over the last 4-year period has been far from consistent, with annual returns being considerably more volatile than the S&P 500. Returns for the stock were 125% in 2021, -50% in 2022, and 239% in 2023. In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, is considerably less volatile. And it 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. Given the current uncertain macroeconomic environment and potential changes in the AI landscape, what’s the downside for Nvidia stock?

How does this impact Nvidia’s valuation? 

If we combine about 1.2x revenue growth (up 20%) between FY’25 and FY’27, with margins contracting from 50% levels currently to about 35% (down 30% from current levels, or 0.7x), this would imply that net income could decline by about 15% by 2027. Now if earnings shrink by 15%, the P/E multiple is bound to take a hit as investors re-assess Nvidia’s position as a growth stock. Moreover, changes to U.S. monetary policy could also impact high multiple tech stocks to an extent. During its meeting earlier this week, the Central bankers signaled a slower pace of rate cuts ahead. Policymakers reduced the number of quarter-point cuts they expected for 2025, from an average of four back in September to just two presently. This could be a sign that the era of very low interest rates seen through Covid-19 is behind us. If Nvidia’s P/E gradually shrinks from a multiple of about 44x now to about 25x, this could translate into a decline in Nvidia stock to about $65 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 3 – if the competitive threat plays out and Nvidia’s GPU cash cow faces headwinds, we could see a sizable correction. 

[1] Returns as of 12/19/2024
[2] Cumulative total returns since the end of 2016

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