Why Is a Prolonged Iran War Bearish for Nvidia Stock?
On the face of it, a company making Graphical Processing Units (GPUs) should have nothing to worry about the oil prices, right? Not quite true.
Even if leading technology company Nvidia Corporation (NVDA) does not utilize oil in its business, it feels the heat when oil prices are on fire. That’s because the stock market does not treat a stock based on what it is producing today. It prices them based on the environment in which its products will be used in the future. Oil, as we all know, feeds directly into the economy we live in. This means the ripple effect reaches all businesses, including Nvidia.
This also makes a stable Middle East, which accounts for half of the world’s proven oil reserves and one-third of its daily oil production, crucial for the global economy. When President Donald Trump comments that Iran will be ‘hit hard’, the resulting chaos in the region is reflected in the oil prices. In turn, this reflects upon the state of the global economy, which eventually negatively impacts all businesses. Nvidia operates in the same economy, and therefore, the longer the Iran war continues, the harder Nvidia’s valuation compresses.
This is also true for the whole AI industry, which arguably had run ahead of fundamentals leading up to the war. The AI trade is unwinding now. Inflation is likely to stay elevated, and so are interest rates. High-growth tech stocks are taking a hit and will continue to do so as the war prolongs, including giants like Nvidia.
Headquartered in Santa Clara, California, Nvidia’s operations primarily including the development and design a wide range of products, including graphics processing units (GPUs) and networking products that are used primarily in AI applications and infrastructure. The firm targets various global markets, including but not limited to industrial AI, the gaming industry, professional visualization and design, healthcare, and life sciences. It is led by innovator Jensen Huang, who has been at the helm of affairs at Nvidia since it was founded in 1993.
The broader semiconductor industry, through the Semiconductor iShares ETF (SOXX), has posted an impressive performance of 14.26% so far this year. During the same period, the S&P 500 Index ($SPX) is down 3.41% while Nvidia is down 4.75%. This is in part due to the memory supply issues, where some stocks have skyrocketed, posting impressive, outsized returns.
Nvidia continues to trade at valuations it hasn’t traded at in the recent past. Despite the company increasing its net income by 27.9 times, free cash flow by 22.61 times, and cash pile by 4.7 times in just three years, it continues to trade at a forward price-to-earnings of 22.93 times. For context, this is just above the S&P 500’s forward PE ratio of 21.19 times and 52.13% below the stock’s own 5-year average forward price-to-earnings of 44.74 times. Even the forward price to cash flow ratio is currently trading at a 51.56% discount to the 5-year average.
For a company that is the leader in AI infrastructure and miles ahead of the nearest competition, this lack of a premium is mind-boggling. The stock can go much higher from its current valuation.
Now the norm, a prominent momentum in the AI-focused data center business was visible in the company’s fourth-quarter results. It reported adjusted earnings per share of $1.62 versus $1.53 estimated by Wall Street. Also, revenue came in stronger than expected at $68.13 billion. This was a significant 73% year-over-year (YOY) increase. Growth was driven by the data center segment, which generated $62.3 billion. Annual net income doubled to $43 billion from $22.1 billion in the previous year.
The guidance was better than what Wall Street expected. According to the management, for the first quarter of the fiscal year, revenue is projected to be $78 billion, give or take 2%. Analysts had originally expected it to be around $72.6 billion. The management is upbeat about the prospect of delivering the next generation Vera Rubin rack-scale systems, which is an upgrade to the Grace Blackwell system.
During the last two weeks, Nvidia has received significant analyst interest. On April 2, DBS analyst Fang Boon Foo raised the firm’s price target on Nvidia shares from $180 to $200. Prior to that, Benchmark Co. and Rosenblatt Securities had assigned a price target of $250 and $325, respectively.
Furthermore, of 49 Wall Street analysts currently cover Nvidia stock, a consensus “Strong Buy” rating doesn’t come as a surprise. The stock is trading 51.3% below the median price target of $268.80, which again shows its failure to appreciate as per Wall Street’s expectations despite delivering amazing results. This is precisely what provides its attractive current valuation.
On the date of publication, Jabran Kundi did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. This article was originally published on Barchart.com