Morgan Stanley’s new Tesla analyst cuts stock rating on rich valuation
The AI juggernaut was down about 15% in November.
It was not a great month for technology and AI stocks as investors drew back a bit due to what some fear may be an AI stock bubble.
The whole question of whether this is an AI bubble akin to the dotcom bubble or even the technology bubble of 2021 is open to debate. But what is less debatable is that tech stock valuations are historically abnormally high after three straight years of sky-high, and in some cases, triple-digit returns.
Few, if any, stocks have enjoyed the success that Nvidia (NASDAQ:NVDA) has in recent years, as its returns are staggering.
Over the past three years, it has had an average annualized return of 119% and over the past five years it has posted an average annualized return of 68%. This year, Nvidia stock is only up 33% — but that is still a ridiculous number by most standards.
But in November, Nvidia hit a wall, as the stock price fell some 15%, making it the worst-performing stock on the Dow Jones Industrial Average index.
Why was Nvidia stock down in November? It wasn’t the chipmaker’s third-quarter earnings, as the company set revenue and earnings records. Its outlook also called for 14% revenue increase in Q4, fueled by new deals with AI companies Open AI, Anthropic, and Humain, as well as partnerships with Oracle and Intel.
Increasing Competition and Profit-Taking
The more likely cause of the November selloff is Nvidia’s high valuation. It had been trading at about 57 times earnings at the end of October and now it is down slightly to 43 times earnings. But that’s still high, even for an earnings machine like Nvidia.
But its forward P/E, based on expected earnings, is a reasonable 23 and its longer-term five-year PEG ratio is under 1, which suggests it is undervalued long term.
There have also been some concerns about the potential for trade restrictions to China to impact Nvidia’s revenue growth in that major market.
In addition, the news that Google was developing its own AI chips, and that Meta Platforms was interested in them, led to increased uncertainty about whether Nvidia can maintain its dominance if hyperscalers start developing their own chips.
Analysts are still bullish on Nvidia, however. Nvidia stock has a median price target of $225 per share, which suggests 26% growth over its current price. That is below the pace that it has been on over the past three years but still marks a robust return for investors.
It is too difficult to predict how the increasingly competitive and ever-changing AI arena will evolve over the next few years, but for right now, Nvidia remains at the center of it all.
And at this reduced valuation, and better yet, this downright reasonable forward PE and low five-year PEG, Nvidia stock looks like a great option right now.