Jan 17 2022 - Nvidia Is Building Worlds

Summary

  • We recently recommended taking some profits on NVDA after the last earnings report, but now circling back to buying more to boost the core position.
  • The valuation is absurd but the growth will make up for this, even if revenue growth may slow.
  • While this is a chip name, the real commodity it's dealing in is data.
  • The total addressable market is impossible to quantify because we are talking about worlds that do not exist yet.
Matrix: The door

 

hamzaturkkol/E+ via Getty Images

Nvidia Corporation (NVDA) is one of several semiconductor stocks we have recommended to our members as we believe that the overall sector is one that is moving away from being highly cyclical into one that will enjoy ongoing demand. This is because the demand for chips is not going to slow, in our opinion. They're in everything it seems these days. Looking at our investment in the name, the stock has truly been a winner. A few months ago when the stock was at 0 we recommended taking some of the gains off the table. We're traders, but that does not mean we do not invest. In fact, when we have trades that result in 50% or more, we often will take out our initial investment plus some profit, and let the rest run with the house's money forever. This is a solid strategy. That being said, we added to our position today in an effort to trade around the core position. While executing this is often more work than the average investor can bear, it's a way to increase profits. With that said, the price correction of about 15% is attractive for entry here. If you are new to the stock, here is how we would enter it.

 

The play

Target entry 1: 5-7 (20% of position)

Target entry 2: 0-1 (30% of position)

Target entry 3: 8-0 (50% of position)

Target exit on a trade: 0

3-year price target: 0

No stop loss is recommended at this time

Options considerations: With high dollar stocks, consider deep in the money call options, such as a January 2023 0 strike. For nearer-term leverage and faster potential returns look to the Jun 5 call strike.

Discussion

Make no mistake, the company is firing on all cylinders, and the sector's demand has never been stronger. We see the sector as outperforming the broader market this year. That said, the stock's valuation, even after the 15% decline is a bit stretched in the near term, but we're more than confident that the stock will grow into this valuation. Let us first start there.

The stock's valuation receives a Quant rating of an F from Seeking Alpha:

NVDA stock valuation

NVDA Valuation metrics

Seeking Alpha

This is no surprise as this is a growth name. But it's expensive on nearly every metric except one. The PEG ratio, and that's because there's true growth here. That takes us over to the same ratings for growth:

NVDA stock growth

NVDA growth metrics

Seeking Alpha

Oh, look, A-rated growth. That's top-notch. So when someone tells you this stock is expensive, simply agree. It is, compared to many other everyday stocks. But when you're factoring in the recent decline in valuation, along with what we think is increasing odds for earnings' revisions higher, the growth metrics balance out the valuation. Just look at that revenue and EBITDA growth. Pretty solid.

There's a lot of anxiety over the Arm Holdings deal for billion. That has been covered extensively, so we will not discuss it here, but we see it complementing the company quite nicely. It can and will impact the future outlook, but some of the most attractive features of the stock cannot be reflected in metrics with or without Arm. What we are talking about here is the potential impact of Nvidia's tech in the medium to long term. Obviously, their graphics cards are exceptional. There's huge demand for them in higher-end computers. Chips have been called the "new oil" but that's not the true commodity of concern.

Where your average trader does not understand or appreciate the company longer term is the dominance that this name has in data. Data is a commodity, in our opinion. Strike that. It is the commodity. Machine learning, decisive marketing, targeted advertisement, this is just the surface of what data can help with. Nvidia has at its fingertips access to a vast amount of data through its traditional computing hardware business, but also in its gaming platforms such as GeForce Now (which just provided a workaround for Fortnite and Apple (AAPL) iOS by the way), CUDA parallel computing platform, and its many software platforms including the game-changing Omniverse. All of this feeds the potential for expansion of its already impressive artificial intelligence work. For more on this topic see this informative piece.

 

The stock has garnered a lot of attention from traders, investors, and meme stock chasers alike. Fundamentally, even with Nvidia's chips being used in technologies that are in our everyday lives, and the demand has never been higher. One place where chips are in demand is in the automotive industry. All new cars use them in some fashion. But the smarter the car, the better the chips that are needed. This is another growth opportunity we see for NVDA and why we think after a 55-60 point pullback it is time to add for the medium term. The demand in autos circles back to the Omniverse. You see, this is much more than a graphics card business. It sounds silly to say it, or, to read it, but there are many investors who simply do not realize it. Specifically, with cars, the company has its NVIDIA DRIVE products which are for use in self-driving vehicles. This series of products isn't just a chip, is the entire computing system in the vehicle. Keep in mind these products also collect mountains of data from sensors. This is mostly of course to ensure better operation of the vehicles. For more on the opportunity in cars, see this solid piece.

We will come right out and say it. Management here is the best in the business, and there are some great management teams that we have spoken with over the years. But Jensen Huang's leadership is outstanding. He took the company from one that was trying to expand outside of its traditional boundaries into a company that is a leader in multiple fields, using data as its commodity. Now, one of the bearish arguments to the growth story is that revenues are going to slow some. This is true, but the opportunity that lies ahead with the Omniverse cannot be understated. The Omniverse engine is the technology infrastructure that produces and uses the commodity of data to make the world a better place. In fact, we will go farther and say it is a world in itself being created. The data will of course feed back to the artificial intelligence growth we alluded to. Eventually, the Omniverse engine can be a place where companies go to create and design new and exciting virtual worlds. You cannot even estimate the total addressable market. It may approach infinity if you really go down the rabbit hole on this. Worlds within worlds, all using the phenomenal technology infrastructure and data that Nvidia has at its fingertips. It is not science fiction either, it is happening as we type. Worlds that do not exist yet will be built.

So is the stock a buy? We think it's still expensive, but new money coming in is getting a piece of the long-term plan of this company. It's a chip play, but it is rapidly becoming so much more than that. Their competencies are broadening each year. This is becoming a juggernaut that just happens to make chips too.

 

So where do we see growth continuing? We believe based on the current state of affairs that revenue growth is going to slow some and that the market is digesting that. We're ballparking a 25-35% CAGR over the next three years. This may be conservative even, but would still make for a very attractive entry point. We see growth driven primarily by investments in data center expansion. We see the company building out and having its customers move ever-increasing portions of their workloads to the cloud and to its artificial intelligence platforms. Keep in mind the data. The company will analyze the absurd levels of data that will be generated further fueling growth and self-learning. We believe that demand in gaming will take a slight dip as the latest gaming systems become more mainstream and saturated, while PC demand should remain stable. Omniverse, as well as the smart vehicles, enhanced robotics, and software-as-a-service as a whole should grow sharply in this time offsetting other slowdowns in the next few years.

Take home

We took some profit off the table in November and have begun redeploying into the core investment. Trading around a core position is difficult and not for everyone, but when executed properly magnifies gains. That said, we see NVDA not just as a short-term opportunity, but one that can build generational wealth as their technology expands into new markets, some of which are so big and broad they cannot be defined or have not even been created yet. No one (or probably very few people) is talking about how wild it is that there are markets that cannot be quantified because they have not been created yet.

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