When analyzing Nvidia (NASDAQ: NVDA), you can probably forgive some investors for writing it off as overvalued. The stock is up around 12-fold since its bear market low in 2022.
Its valuation and growth rate stoke fears that it’s flying too close to the sun and will crash when its wings melt.
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Even its most ardent bulls will concede it is not a cheap semiconductor stock. Still, saying it’s “too close to the sun” is likely an exaggeration, and here’s why.
The Nvidia revolution
Nvidia changed the face of the semiconductor industry upon the release of an upgraded version of ChatGPT in early 2023. When observers saw that AI accelerators powered the upgraded performance, demand for these AI chips went into the stratosphere, and Nvidia was the company best prepared to meet the demand.
Consequently, this product has fundamentally changed Nvidia. Three years ago, in the third quarter of fiscal 2022, the data center segment, which designs AI accelerators, contributed a smaller share of revenue than Nvidia’s original business, gaming.
However, by the third quarter of fiscal 2025 (ended Oct. 27), the data center segment accounted for 88% of revenue!
Indeed, competitors such as AMD, Intel, and Qualcomm have scrambled to close the competitive gap. Since demand for AI accelerators exceeds the supply, the competitors have a market. Nonetheless, Nvidia’s innovation has kept it firmly in the lead in this area. With this ability to stay ahead, it is unlikely any of its competitors will catch up anytime soon.
Signs of trouble for Nvidia stock
You might assume Nvidia has flown too close to the sun when looking at some of its results more closely.
At first glance, they point to phenomenal growth, with its fiscal third-quarter revenue of $35 billion rising 94% year over year. With that increase, its net income of $19 billion was up 109% over the same period.
Investors should remember that large companies tend to grow more slowly due to the law of large numbers. Hence, the fact that Nvidia can grow so much despite its $3.2 trillion market cap is nothing short of impressive.
Still, over the first three quarters of fiscal 2025, its revenue grew 135%. That led to a rise in net income of 190%, indicating a slowdown has begun.
Triple-digit revenue growth is unsustainable even for companies that are a fraction of Nvidia’s size. Still, investors tend to punish stocks when those increases inevitably slow, which may be happening to Nvidia.
And its valuation could contribute to the decline. A superficial look at its stock may not indicate any overvaluation since its trailing P/E is 52. Also, its price-to-sales ratio (P/S) of 29 is probably elevated but not unheard of for a high-flying tech stock.
But its ratio of price to book value (P/BV) arguably places the stock in bubble territory. Currently, Nvidia trades at a book value multiple of 49, far above the P/BV ratios of AMD and its leading manufacturer, Taiwan Semiconductor, which sell at 3.6 times and 8.3 times book value, respectively. That massive premium could prompt more investors to sell the stock even as it continues its dominance with AI accelerators.
Is Nvidia flying too close to the sun?
Although Nvidia is likely to feel some heat in the near term, it is likely not too close to the sun.
Given the slowing revenue growth and the 49 P/BV, the price of the stock is undoubtedly ahead of itself. This could lead to struggles or outright declines in the short term and possibly beyond.
However, its massive growth should increase Nvidia’s “heat resistance” over time. When its sales and book value multiples fall to a level that is more in line with its growth and earnings, the company will be able to fly at higher altitudes — likely higher than it does now.
Hence, even if Nvidia appears too close to the sun right now, investors should not expect that to be the case over the longer term.
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Will Healy has positions in Advanced Micro Devices, Intel, and Qualcomm. The Motley Fool has positions in and recommends Advanced Micro Devices, Intel, Nvidia, Qualcomm, and Taiwan Semiconductor Manufacturing. The Motley Fool recommends the following options: short February 2025 $27 calls on Intel. The Motley Fool has a disclosure policy.