Key Points
The bull case for Nvidia centers on the assumption of continued strong demand for its chips due to AI.
If expectations are wrong and there's another bubble in tech, however, the stock could be vulnerable to a significant sell-off.
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It may seem ludicrous: the idea that a company with a $5.3 trillion valuation and the largest market cap of any publicly traded company might still be a cheap buy when factoring in its growth potential. But that's precisely the bull case for chipmaking giant Nvidia (NASDAQ: NVDA).
While it has a sky-high market cap, it's backed by strong financials. The company has been a profit-generating beast over the years, so its valuation relative to earnings isn't outlandish. Some analysts and investors even argue that it may be a bargain.
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Is that really the case, and is tech stock a good buy, even at its elevated levels?
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Nvidia's stock seems like a bargain -- if you believe analyst projections
A key metric for growth investors to gauge a stock's value based on its long-term growth rate is the price-to-earnings-growth (PEG) multiple. It takes into account the stock's current earnings multiple and divides it by the expected growth rate over the next five years. If it's below 1.0, then the stock is considered a cheap buy. And the lower the PEG goes, the better of a buy it is.
Currently, Nvidia's PEG multiple is 0.62, well below the 1.0 cutoff. This relies heavily on the assumption that tech companies will continue to invest heavily in artificial intelligence (AI) and that Nvidia's chips will remain in high demand, enabling it to grow its top and bottom lines at a high rate for the foreseeable future.
But expectations can be wrong. While AI can enhance day-to-day operations, there's a risk that expectations have gotten out of control yet again and that another bubble has emerged. If that happens and the growth story unravels, then Nvidia, along with a flurry of tech stocks, could crash. If not, and AI proves to be the game changer many believe it will be, then Nvidia is indeed a cheap buy and may still rise a whole lot higher.
Why I wouldn't buy Nvidia
I'm skeptical about all the AI growth, but that's not the only reason I'd be careful with Nvidia. Even if the business continues to flourish, I don't believe the stock has much more runway to become more valuable. Even in the bullish case where AI spending remains strong, Nvidia may inevitably run out of room to rise higher. Plus, the more lucrative the opportunity, the more competition there will inevitably be. Tech companies have already been making their own chips, and those efforts could intensify.
Nvidia has been a terrific growth stock, but with so much depending on future expectations and so much vulnerability, it's not an investment I'd feel comfortable holding, especially when there are so many other quality growth stocks to choose from.
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David Jagielski, CPA has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Nvidia. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
