This year has been anything but boring so far for Nvidia (NASDAQ: NVDA) shareholders. The Nvidia stock price has soared 66% in under two months to hit an all-time high in today’s (3 July) US market session.
That means that the chip company’s stock now trades 1,572% higher than five years ago. That is the sort of return that would leave many investors laughing all the way to the bank.
Looking at it, I wonder whether I am too late to start buying Nvidia stock now – or if it may move even higher in future.
Valuation looks high but not ridiculous
Let us begin with the current valuation. Nvidia stock is changing hands for 52 times earnings.
That is definitely on the high side in my view of what constitutes value, even for a growth stock. In fact, that valuation alone means I am not willing to buy at the current price.
However, while I think it is high, I do not think it is ridiculous. Some growth stocks trade on a three-figure P/E ratio. Tesla is an example – but Nvidia’s short- to medium-term business growth prospects look better than Tesla’s, in my view.
One of the wildcards in all of this is Nvidia’s earnings. Over the past five years, the company’s basic earnings per share (EPS) have grown a staggering 2,700%.
Cheaper than before, even at a record high
So, in one sense, Nvidia stock is actually cheaper now than it was five years back. Sure, the stock price has jumped 1,572%. But that is markedly lower than the growth in basic earnings per share.
I see this as a wildcard because earnings movements are a critical factor in deciding what a fair share price might be. If Nvidia continues to grow EPS sharply – even at a far slower rate than before – its prospective P/E ratio could be far less than 52. Even the current share price could then turn out to be a long-term bargain.
But what if recent earnings are a one-off blip due to high expenditure by firms on building AI infrastructure?
Should that turn out to be the case – and there is a risk it will – the prospective P/E ratio could be much higher than 52. That may mean that Nvidia stock falls to a price far below its current record-setting level.
Sitting tight for now
Valuation is important because overpaying even for a great business can be a costly mistake.
I see a lot to like about Nvidia. It is hugely profitable, has unique expertise, and proprietary designs, and is selling high-margin chips to a large installed customer base.
I reckon that could mean the share moves even higher and of course I would like to benefit from that. But so I do not get carried away, I also need to feel comfortable with the margin of safety a share price offers me.
Tariff disputes and growing competition are both risks to Nvidia’s sales, alongside an unclear medium-term outlook for AI chip demand. So, at the current price, I am not willing to buy Nvidia stock.
This story originally appeared on Motley Fool
