Nvidia and The Coming Darkness

Nvidia and The Coming Darkness

In a more serious sector of the market, we have $NVDA making a historic move to a new ATH ($380) on the speculation of transformative AI breakthroughs. Recession fears lying dead in the trunk of the starship rocket. With the price of used GPU’s sliding to the downside since early 2022, it’s hard to understand where the priced in demand will come into fruition.

Last quarter, Nvidia’s profit surged 26% to $2 billion, and sales rose 19% to $7.2 billion, each easily surpassing Wall Street analysts’ forecasts. Nvidia’s outlook for the current quarter was also significantly — about 50% — higher than analysts’ predictions.

The pump is based on forward earnings estimates along side the speculation on new AI tech. Let’s break down these two individually and see if this historic move is justified.

Let’s begin with Generative AI as this is the premise for massive forward anticipated demand. So powerful and transformative it will transcend and eclipse the likely incoming recession.

Generative AI is a type of artificial intelligence technology that can produce various types of content, including text, imagery, audio and synthetic data. The recent buzz around generative AI has been driven by the simplicity of new user interfaces for creating high-quality text, graphics and videos in a matter of seconds.

Going forward, this technology could help write code, design new drugs, develop products, redesign business processes and transform supply chains.

What are use cases for generative AI?

• Implementing chatbots for customer service and technical support.

• Deploying deepfakes for mimicking people or even specific individuals.

• Improving dubbing for movies and educational content in different languages.

• Writing email responses, dating profiles, resumes and term papers.

• Creating photorealistic art in a particular style.

• Improving product demonstration videos.

• Suggesting new drug compounds to test.

• Designing physical products and buildings.

• Optimizing new chip designs.

• Writing music in a specific style or tone.

These seem like great conveniences for the modern world. Transformative recession resistant groundbreaking technology? Not so much. AMD has shared a small fraction of the liquidity wave incoming for AI tech. They over expanded their business ventures in late 2021 as we slid into a major market pullback based on inflation fears and fed tightening. Is this a leading indicator of what’s to come for NVIDIA’s aggressive expansion moving into a recession yet to be priced in? Maybe.

NVIDIA has the technicals, financials and narrative on its side. All of which can change on a dime. What really matters are valuations which are flashing red in an alarming way.

The new all-time high price wasn’t the only new ATH for NVIDIA.

Let’s look at some indicators for NVIDIA.

Price to earnings P/E (TTM)

• NEW ATH – 218x (2023)

• OLD ATH – 97x (2017)

We’ve seen a significant rise in the P/E ratio in a very short period, which indicates a large amount of speculation on NVIDIA.

Price to Sales P/S (TTM)

• NEW ATH – 34.8x (2023)

• OLD ATH – 26.2x (2021)

P/S at 34.8x is extremely high, it’s also important to note that we’re at higher levels currently than we were at peak mania back in both 2021 & 2017. You will be dead before earnings catch up with current valuations, your children would also likely expire prior to these valuations making sense. We could call this a multi-generational investment strategy at best. Jokes aside, it’s more likely than not that we will see a massive correction in NVIDIA stock price. Insider sell volume continues to grow over the last 3 quarters and is likely to continue throughout 2023 and into 2024.

Nvidia is not a small startup. Its sales amounted to $27bn over the past year, while its free cash flow came in at $3.8bn, reflecting a free cash flow margin of 14%, which is higher than the NDX average of 12%. Such extreme valuation ratios are rare for large established companies as growth is a declining function of market size.

The combination of speculative trading activity, particularly in options markets, and the allure of a new game-changing technology often come together to create spikes in stock prices that are far out of line with any fundamental developments. As a stock's price rises, its gain attracts attention and strengthens the credibility of the underlying bullish story, which creates further buying interest. When a high volume of option trading takes place as in the case of Nvidia currently, this adds fuel to the fire as relatively small amounts of individual capital can have an outsized impact on prices.

We often see investors abandon traditional valuation methods or ignore valuations altogether when a fashionable stock such as Nvidia rallies significantly beyond its earnings potential. Many recent articles on Nvidia do a good job of explaining why the company will grow strongly yet ignore the issue of valuation.

As much as I enjoy my NVIDIA GPU, AMD has bridged the gap in performance at a cheaper price. NVIDIA are well known for being overpriced in the gaming industry. Future growth at this valuation almost completely relies on AI rapidly improving to another level again from here. This is screaming sell the news IMO. Given everything we’ve gone over and the coming recession, NVIDIA cannot possibly keep up with their projections in the most recent report. If you don’t believe the recession is coming, just remember a 3-month and 10-year inversion has never been wrong.

It is very easy to see the flaws investing in something like $PEPE or $GME. NVIDIA on the other hand is a good company and does a great job of projecting believable future growth.

Beware the Phantom.