Shares of Nvidia (NVDA -1.10%) have taken off impressively in 2023 with gains of 93% so far, driven mainly by the artificial intelligence (AI) hype train that has led Wall Street to overlook the recent challenges faced by the company.
Weak sales of personal computers (PCs) and a pullback in data center spending have weighed heavily on the semiconductor giant's revenue and earnings in fiscal 2023 (ended on Jan. 29). Its annual revenue was flat at $27 billion, while adjusted earnings fell 25% over the prior year to $3.34 per share. A turnaround is expected in the current fiscal year, with revenue expected to increase 11% to $30 billion. Analysts expect a 36% spike in Nvidia's earnings to $4.53 per share.
However, it may be too early to be optimistic about a turnaround at Nvidia as the bears might come out in full force when the company releases fiscal 2024 first-quarter results later this month. Let's see why.
The bearish case against Nvidia stock
Nvidia gets a nice chunk of its revenue from the PC market. The company sold $10.6 billion worth of graphics cards used in gaming PCs and workstations last fiscal year. Gaming was the bigger business for Nvidia, as the segment generated just over $9 billion in sales. However, the combined revenue of the gaming and professional visualization businesses, which are directly dependent on the PC market's health, was down 27% year over year from $14.6 billion in fiscal 2022.
This sharp decline isn't surprising as PC sales fell 16.5% in 2023 to 292 million units, according to IDC, leaving a lot of unsold graphics card inventory with Nvidia that hammered the company's margins. The bad news for Nvidia investors is that the PC market had a woeful start in 2023. IDC estimates that Q1 2023 PC shipments fell a whopping 29% year over year to just 57 million units.
The market research firm further added that channel inventories continue to be high despite a correction in the past few months. More specifically, IDC points out that PC inventory levels remain higher than the four-to-six-week range that's considered ideal for the industry. Even worse, inventory levels could remain elevated even in the third quarter of the calendar year.
IDC expects a PC market recovery to happen only toward the end of 2023 but adds that a potential recession could play spoilsport and delay a turnaround. As PC graphics cards produced almost 40% of Nvidia's revenue in fiscal 2023, the worsening conditions in this market strengthen the bear case against the stock -- especially considering the steep valuation.
Nvidia stock trades around an expensive 160 times trailing earnings. The forward earnings multiple of 62 points toward an improvement in the company's bottom line, but even that is quite high considering the average five-year forward price-to-earnings ratio of 40. Moreover, the PC market's worsening conditions could keep Nvidia from hitting Wall Street's estimates in fiscal 2024 and bring a halt to the stock's terrific rally.
The bulls may have the last laugh
The PC market turmoil is, no doubt, a reason to worry for Nvidia investors, but the rapid growth of the company's data center business is likely to strengthen the bull case and help the tech stock sustain its hot rally.
That's because the data center business now exercises greater influence over Nvidia's top line. The company's revenue from this segment was up 41% in fiscal 2023 to $15 billion, which was 55% of its top line. For comparison, the data center business produced 39% of Nvidia's total revenue in fiscal 2022. The robust growth in data centers played a key role in helping Nvidia offset the sharp decline in revenue from its PC-centric businesses.
A similar story is likely to unfold in the new fiscal year as well, driven by the healthy demand for Nvidia's graphics processing units (GPUs) in the generative artificial intelligence (AI) market. Nvidia's expensive H100 Hopper chips -- which reportedly cost upward of $30,000 -- are in great demand thanks to their AI training capabilities. The company's chips are powering generative AI applications from the world's biggest cloud service providers, including the likes of Amazon and Microsoft.
Amazon Web Services (AWS), for instance, is offering customers on-demand access to as many as 20,000 Nvidia Hopper H100 GPUs for their AI computing requirements so that they can build and train large language models (LLMs) and develop generative AI apps. Meanwhile, Microsoft has already deployed thousands of Nvidia GPUs to power ChatGPT, and it could deploy more as it integrates generative AI into more services.
Citigroup sees ChatGPT alone generating between $3 billion and $12 billion in revenue for Nvidia over a 12-month period. That would be significant considering the revenue Nvidia's data center business generated last fiscal year, even at the lower end of Citi's forecast. However, Microsoft isn't the only one tapping Nvidia's GPUs for generative AI, so it won't be surprising to see this technology move the needle in a bigger way for the chipmaker and further accelerate the growth of its data center business.
What should investors do?
While the PC market's weakness does present a bearish case for Nvidia stock, the strength in the data center market could be enough to help the company put up robust growth numbers in the current fiscal year and beyond. The momentum in the data center market, along with emerging catalysts such as the omniverse and the automotive business, could help Nvidia sustain impressive earnings growth.
That's why Nvidia bulls should be on the lookout for any pullbacks in the company's stock price caused by the weakness in the PC market, as the solid growth of the data center business could help it deliver a healthy upside in the long run.
