Nvidia (NVDA -1.10%) is one of the most widely followed stocks today, and it's easy to see why. Its lead in the artificial intelligence (AI) accelerator market supercharged its revenue growth and made it the largest semiconductor stock, as measured by market cap, next to Apple.
Unfortunately for investors who want to buy Nvidia shares, its success has made determining whether it is a buy now a more difficult problem. Do its technical lead and continuous improvement make it a no-brainer buy, or has its valuation made it too expensive to touch at current levels?
Nvidia's dominance
As most tech investors know, the company's AI accelerators and the revenue gains caused most of the growth in the stock price. With that, the data center segment that designs AI chips went from the company's second-largest revenue source to producing 88% of company revenue in just three years.
This is fortuitous when considering the state of the growing AI chip industry. Grand View Research forecasts a compound annual growth rate of 29% through 2030. Between the predicted growth and shortages in accelerators, Nvidia is also the company best positioned to serve this market.
The innovation does not stop with accelerators or the CUDA software platform that cements its AI chip dominance. Nvidia has continued to develop numerous new products, some of which it just announced at CES.
This includes a graphics card built on Blackwell architecture and other AI-driven advancements designed to power humanoid robots and self-driving cars. Even though time will tell how these products perform in the marketplace, this innovation increases the likelihood that Nvidia will play an even more essential role in the tech industry in the foreseeable future.
Dangers in its financials
To that end, Nvidia generated $35 billion in revenue in the third quarter of fiscal 2024 (ended Oct. 27, 2024), a yearly increase of 94%. Amid that improvement, it earned $19 billion in net income in fiscal Q3, a 109% rise from year-ago levels.
Indeed, investors should be thrilled to experience such growth, and experienced investors know that the triple-digit revenue increases of past quarters are not sustainable.
Unfortunately, investors tend to punish stocks for slowing revenue growth, and the company's valuation may leave it vulnerable, at least if digging beyond the surface.
On the surface, its price-to-earnings ratio of 53 is above S&P 500 averages, though many slower-growing tech stocks have a higher earnings multiple. The price-to-sales (P/S) ratio of 30 better highlights how expensive the stock has become, but that may not deter investors who want to benefit from Nvidia's rapid growth.
Nonetheless, the price-to-book value ratio of 51 takes its valuation into nosebleed territory. In comparison, AMD trades at just over 3 times book value.
Additionally, Nvidia's success makes it more subject to the cyclicality that has always defined the semiconductor industry. Indeed, the stock prices may hold, and it is possible that Nvidia stock will avoid a significant downturn in the near term.
Still, its situation points to a key vulnerability. New AI accelerators sell for more than $30,000. However, if demand falls, prices will likely follow, a factor that could reduce or even reverse the company's revenue growth.
Nvidia stock has also experienced pullbacks of more than 50% twice in the last seven years. Such a reversal could bring about another significant decline.
Thankfully, cycles also move upward at some point, so Nvidia stock should eventually recover from any downturn due to its new technology. Still, considering that a down cycle will inevitably occur at some point, investors may want to think twice about making huge purchases at this time.
Should I buy Nvidia stock?
Under current conditions, investors should treat Nvidia as a hold. Considering its valuation metrics and the chip industry's cyclicality, investors are likely overpaying for Nvidia at its current price.
Nonetheless, the company benefits from clear dominance in the AI chip industry, and that is unlikely to change soon. Moreover, its continued innovation will likely cement that dominance and foster more long-term growth.
Hence, when balancing Nvidia's attributes with its challenges, staying the course is probably the best action for its shareholders.
