Nvidia’s Stock Decline Raises Industry Worries
Nvidia, a prominent player in the AI market, witnessed a significant drop of nearly 7% over two days late last week, raising apprehensions regarding the sustainability of its meteoric rise in stock price. The company briefly surpassed tech giants Microsoft and Apple mid-week to claim the title of the world’s most valuable company before sliding back to third place by Friday’s market close. Investors are now deliberating whether to capitalise on profits from Nvidia (NVDA) and the broader AI sector or persevere with the prevailing trend that has underpinned much of this year’s gains in the S&P 500.
Putting the recent 7% decline into context, it’s crucial to note that Nvidia shares have still surged by an impressive 156% year-to-date. Despite last week’s dip, which is relatively minor and barely discernible on a long-term chart, investors should anticipate significant and occasionally turbulent downturns from companies that have experienced rapid expansion. Nvidia exemplifies this trend, having endured a 66% share price plunge at one point in 2022 and weathered four drawdowns of approximately 15% or more within the past year alone.
However, several factors are prompting investors to reevaluate their confidence in the ongoing rally. The company’s ascension to the position of the world’s most valuable firm amidst a backdrop of declining economic momentum raises legitimate concerns. Additionally, the overwhelming dominance of large-cap tech stocks at the index level presents another challenge. Furthermore, the notable outperformance of AI-related stocks in recent months compared to the broader market has reignited discussions about potentially “bubble-like” price activity. These apprehensions necessitate a pause for reflection and contemplation on Nvidia’s trajectory from a broader perspective to ascertain whether the current share price appreciation is justified.
Evaluation of Recent Dip and Market Concerns
There is no universally defined standard for identifying a stock or stock market bubble; however, historical patterns can provide valuable insights. Typical characteristics of bubbles include rapid and substantial price surges that outpace rational valuations, widespread enthusiasm and speculation among investors often driven by a fear of missing out, and a belief in new paradigms, technologies, or economic conditions that generate excitement concerning future growth prospects. Notably, Nvidia and other AI-related stocks have catapulted to new heights over the past 18 months. For instance, Nvidia’s stock has surged by nearly 800% since the onset of 2023, while tech behemoths like Meta, Amazon, and Microsoft have recorded jumps of 297%, 120%, and 88%, respectively. Despite this near-parabolic ascent, there exists substantive fundamental support underpinning these valuations.
Nvidia consistently outperforms analysts’ anticipations for earnings and profit growth and boasts an estimated market share of 80% in specialised chips crucial for most AI applications. Other technology giants are also demonstrating earnings growth that surpasses many expectations. In a recent milestone, Nvidia’s financial results for the first quarter of fiscal 2025 showcased a remarkable revenue surge of 262% compared to the corresponding period last year, with data centre growth experiencing an even more impressive climb of 427% year-over-year. Accompanied by gross margins of 78%, profits have followed suit, underscoring the robust performance of the business. Evidently, Nvidia’s surge is not solely fueled by speculation, but rather by tangible business achievements.
From a valuation standpoint, Nvidia’s forward price-to-earnings ratio for the coming year stands at 47x, in contrast to 35.9x for the Philadelphia Stock Exchange Semiconductor Index, 29x for the NASDAQ 100 Index, 22.6x for the S&P 500, and 17.8x for the equal-weight S&P 500 Index. While Nvidia’s valuation may appear steep relative to the broader market, it aligns with the company’s rapid revenue and earnings growth trajectory. Investors are increasingly willing to pay a premium for growth, a trend Nvidia has duly delivered on. Traditional valuation metrics applied to fast-growing companies operating in nascent industries often yield limited insights. However, the question remains: are the current multiples overly exaggerated?
In comparison, during the peak of the dot-com bubble in 2000, Nasdaq 100 stocks traded at a staggering trailing P/E ratio of 200, significantly higher than today’s levels. For instance, Cisco, a prominent figure during the dot-com era, boasted a forward earnings multiple exceeding 150 when the stock attained its zenith in March 2000. In this context, neither Nvidia nor the wider market stand close to the valuation peaks observed during the internet bubble. Nevertheless, Nvidia’s recent expansion in earnings and sales multiples suggests a potential divergence between its share price and the operational performance of the underlying business. While AI stocks have surged and valuations have stretched, there appears to be substantive support backing this fervour.
Market Sentiments and Speculation
The options market often serves as a barometer for heightened sentiments surrounding a stock or thematic trend. A notable sign of exuberance is when call option volatility exceeds put option volatility, signalling investors’ anticipation of significant upside potential from existing levels. Presently, both 1-month and 3-month call options exhibit a similar level of implied volatility to put options. This suggests a balanced market sentiment over the past year. While call options were comparatively pricier around last March’s earnings report, the current options pricing does not indicate extreme bullishness. Nonetheless, the fervour surrounding the AI boom remains palpable.
Corporate discussions of AI during earnings calls have reached record levels, with 40% of S&P 500 companies mentioning AI in their recent quarterly calls – a stark contrast to only 1% five years ago, as per data from FactSet. Many companies view AI as a potential productivity booster rather than a direct revenue source, leading to substantial investments in this technology. The widespread enthusiasm surrounding AI’s transformative capabilities is palpable, yet it’s vital to distinguish between enthusiastic adoption driven by proven productivity enhancements and speculative behaviour lacking substantive basis.
