Is This Fast-Growing Tech Stock Worth the Premium?
Sometimes, a stock impresses investors with its outsized growth potential, but it also appears too expensive. Let's look at one such pricey but exciting investment, which is poised to be one of the growth stock winners of 2016.
Nvidia (NVDA) - Get Report is a producer of chips known as "graphics processing units," which are designed for improving the image quality on smartphones, game consoles and cars. Over the years, the company has built a formidable reputation.
From fiscal 2013 through fiscal 2016, the company says its gaming revenue climbed by 30%, datacenter sales grew by 40% and its auto segment expanded an eye-popping 80%. (Nvidia's 2016 fiscal year concluded on Jan. 31.) The company has also transformed its business mix in favor of what it calls "growth platforms," coinciding with the secular decline in demand for PCs.
The company last Thursday released earnings for the fiscal first quarter as well as strong revenue guidance, and the stock surged 16% on the news during Friday's session. Nvidia increasingly looks like a momentum stock with market-beating gains ahead. Now how do you measure and evaluate a situation like this?
Bear in mind, Nvdia shares are trading at a trailing 12-month price-to-earnings ratio of more than 36. That's significantly higher than the S&P 500's P/E of 23.8. Shares are also close to the $42.50 average 12-month price target from analysts who cover the stock. This appears to leave little room for additional appreciation. You may want to wait for some price weakness before you buy this stock.
When you map Nvidia with its competitors like Advanced Micro Devices, Intel and Qualcomm, you can see why the company out-performed semiconductor stocks every year since 2013. By the way, it's also beaten the S&P 500 total return index handsomely in this period.
However, valuations galloped at a fast clip as well. Consider this: NVIDIA, on historical price-to-earnings, trades at 38-times against its own five-year average of 21.9-times. Intel and Qualcomm trade between 12 and 16 times. Expectations that NVIDIA would deliver solid growth over the long haul has pushed investors to bump-up valuations to sky-high levels.
Based on its price-to-earnings-to-growth (PEG) ratio (five-year expected), the stock is available for 1.12 times compared to 1.1-to-1.2 times for Intel and Qualcomm. Last year, its shares out-performed Facebook (34.15%) and Google owner Alphabet (46.6%).
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At about $42 per share, NVIDIA is probably one of the best growth stories available, but it's a tad expensive at this time. You may want to wait for pullbacks.
You could argue that NVIDIA's financials warrant a big premium. Among its strengths are a net debt status with still over $3 billion in cash, improving margin profile, a robust capital return program and 22% earnings-per-share (EPS) growth projections for the next five years.
Howver, the 21 analysts offering 12-month price forecasts for NVIDIA Corp have a median target of $36.00, which indicates a 12%-plus decrease from the latest prices.
But remember, the current consensus among 28 polled investment analysts is to hold the stock. The growth engine in NVIDIA, which is extremely popular because it combines solid hardware with cutting edge software, is its datacenter segment.
The company also continues to execute well and has growth drivers in Tegra and GPUs and more importantly is expecting a resumption of growth from its gaming business driven by its Pascal-based GeForce products in July.
Cyclical stocks like NVIDIA throw up episodes of weakness, which are your best window for an entry point into the stock.
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This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.
