Why Nvidia Fell Today
What happened
Shares of GPU leader Nvidia (NASDAQ: NVDA) fell as much as 5% on Monday, before recovering to a 3.7% decline at the end of trading.
At first glance, there doesn't appear to be any particular news that would have driven Nvidia lower. The Nasdaq Composite is down today more than the broader market, and Nvidia is certainly a large component of that; however, Nvidia shares are down by much more than the index.
In the absence of news, the extended sell-off could be attributed to a prominent valuation professor publishing a long blog post last Friday, in which he concludes Nvidia is only worth about $240 per share, or about 60% of its current value.
Yet before investors panic, one should dig into the professor's rationale.
So what
NYU valuation professor Aswath Damodaran is a widely followed figure who writes detailed analysis of his stock picks and frequently appears in the financial media. Full disclosure: I actually am a former student of his, and still use the professor's valuation frameworks today when attempting to value a stock. For the most part, the professor leans on a discounted cash flow (DCF) analysis, in which a stock's value is worth the present value of all future cash flows, discounted back to the present.
The value one derives from a DCF analysis is based on several factors: growth, margins, capital investments needed to achieve that growth, the length of the high-growth period before "maturity," and the discount rate one uses on future cash flows.
Without delving into every detail, the professor uses a 10-year model, in which Nvidia's revenues grow to $267 billion in 2033, about 10x the amount over the past 12 months. Damodaran also projects about 40% operating margins, which are much higher than today's but are actually not much higher than the recent cyclical peaks of 2018 and 2021.
The professor also forecasts a sales-to-capital ratio (with capitalized research and development costs) rising from $0.65 to $1.15 of sales for every dollar of capital spent over that time. And finally, Damodaran uses a high discount rate of 12.21% today, but gradually falling to 8.85% over 10 years as the inflationary environment abates and Nvidia matures to become less risky.
Now, while that valuation model spits out a $240-per-share value, it should also be noted that Professor Damodaran acknowledges a range of outputs depending on differences in those inputs and assumptions within a Monte Carlo analysis.
Within those simulations, there is a small chance that Nvidia's value actually exceeds the current $407-per-share valuation, although that is assigned a relatively low probability in the analysis.
Also less scary: At the conclusion of the blog post, Damodaran only decides to sell half of his Nvidia position, which he's held since 2018, while "holding on to the other half, more for the optionality (that the company will find other new markets to enter in the next decade)."
Now what
It may seem curious that the professor is holding any shares, given that his base case is 40% lower than shares today. However, while Damodaran makes very precise calculations, he is the first to acknowledge the high uncertainty involved in valuing a growth stock.
Two main factors that could increase that value are severalfold. First, Damodaran is basing his revenue targets on his projections of the AI, gaming, and auto chip markets in 2033, as well as Nvidia's ultimate market share. Not only could those assumptions be wrong, but it's also possible Nvidia may find new markets for its chip design prowess in that time.
Second, Nvidia could achieve higher margins, as the professor doesn't account for much expansion there. But it's also possible margins could expand, given that some chip giants like Texas Instruments have achieved operating margins near 50%.
In any case, the professor's reality check may be playing a part in Nvidia's sell-off today; however, as is the case with any disruptive growth stock, there is a high amount of uncertainty, both to the upside and downside. Yet after Nvidia's massive run this year, it may be prudent for investors to acknowledge the company's lofty valuation and risk to the downside.
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Billy Duberstein has positions in Texas Instruments. His clients may own shares of the companies mentioned. The Motley Fool has positions in and recommends Nvidia and Texas Instruments. The Motley Fool has a disclosure policy.
