Nvidia Overreacts To Guidance

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About: NVIDIA Corporation (NVDA)
by: Kwan-Chen Ma
Summary

In the last two months alone, Nvidia has lost 40% of its market capitalization, mainly due to the two downside revenue guidance revisions.

I developed a forward-looking model which prices the stock based on management’s "guidance changes" on revenue, EPS, and gross margin for the next 4 quarters.

Based on the way how Nvidia's shares were responding to guidance changes, the 40% loss is deemed excessive.

Nvidia’s shareholders have overreacted to the negative information conveyed by the downside revenue guidance.

If just using guidance changes, Nvidia's shares are trading at a $40 discount or undervalued by 23%.

In its Q3 earnings announcement, Nvidia (NASDAQ: NVDA) dropped the bomb shell of lowering the Q4 revenue guidance by 25%, citing crypto-related excess inventory. The stock has plummeted more than 16%. On January 28, three weeks before its Q4 ER, Nvidia’s CEO Jensen Huang came out yet again to warn to lower Q4 revenue guidance, citing weaker sales of its gaming and datacenter platforms, deteriorating macro conditions particularly in China, for customers delaying orders. The unusual move has stunned the market. In addition to Nvidia’s 18% loss, the NASDAQ index also lost close to 3% in concert.

This is a volatile time for the stock market. With ongoing trade war negotiations, Fed’s changing stance of interest rate policy, and looming global economic slowdown, investors are hungry for any clues to indicate the future outlook. Given most bellwether stocks like Facebook (NASDAQ: FB), Apple (NASDAQ: AAPL), Taiwan Semiconductor Manufacturing Company (NYSE: TSM), and Nvidia’s Q3 have been somewhat “punished” by the market for their downside revenue guidance, it is not surprising that Nvidia's shareholders have reacted so violently to the warning of the downside guidance. However, Nvidia has lost close to half of its market capitalization in the last four months and most likely due to the two downside guidance warnings. In this post, I like to show that the 40% loss is excessive if it was just due to downward guidance revisions.

Analysts Estimates React to Guidance

Generally, Wall Street takes management guidance very seriously. As guidance is often the only source of a company’s new information, analysts use it to formulate their estimates and recommendations. When Nvidia lowered their Q4 and Q1 revenue guidance, the Street analysts adjusted their forward estimates almost instantly (the circles in Figure 1). This is why Street estimates are closely tracking guidance and stock prices react to both the changes in guidance and estimates.

("1809": September 2018)

Nvidia's Stock Reacts to Guidance

In Figure 2A, there is a clear correlation between Nvidia's share price drop after October 2018 and the downside revenue guidance occurred around the same time. As guidance has been priced in some time ago, Nvidia's shareholders are more sensitive to guidance revisions (Figure 2B). The intense sensitivity can be demonstrated by the -40% loss in response to the downward changes of Q4 revenue guidance.

(“1808”: 2018 August)

Guidance Compliance Target Price

At this juncture of significant economic uncertainty, it appears that Nvidia's stock price has reacted to the future revenue guidance more than anything else. Using the relationship between Nvidia’s stock price and management’s guidance, I was able to estimate a “guidance-compliance target price” which is determined by the guidance metrics, including management guidance on future revenue, EPS, or gross margin, if provided. The way I came up with this implicit guidance price is as follows: I first collected all management guidance, stock price, and consensus estimate data on revenue, EPS, and gross margin for last 40 quarters, I then correlated Nvidia's stock prices with the management guidance or Street estimates of revenue, EPS, and gross margin for the current and next 4 quarters, if available. The relationship I identified would suggest how today’s stock price moves in response to the management guidance for the next 4 quarters. Furthermore, in the light of tariffs-related, China slowdown impact on the broader market, I also include the NASDAQ index in the estimation to control for the macro impact on Nvidia's stock prices. In Figure 3, I showed how this guidance stock price would have looked like, compared with Nvidia's actual stock prices. For the better part of 2018, Nvidia actual stock price (black line) has moved closely with what guidance has suggested (the red line). This would verify the fact that investors did look at management guidance in pricing Nvidia's shares.

Since October, after Nvidia’s first downside revenue guidance, stock prices frequently dropped below the guidance suggested fair value level. Just in the last few days, Nvidia surprised the market by issuing its second pre-warning of Q4 downside guidance. The stock dropped to $144, which is about $40 below what it should be traded at $186, as implied by the new lower guidance and adjusted by the recent tech rebound. For a further close-up, Figure 4 demonstrates that Nvidia is currently trading at a 23% discount (or undervalued) relative to where the stock should be valued at based on the two downside guidance revisions.

Takeaways

Starting 2H 2018, Nvidia’s legendary stock has entered a new phase. Most likely, the historical year-to -year over 200% annual growth will not be back in the near future. Investors need to come to the ground that stock prices should be valued at the forward-looking financials in the long run. We have learned that harsh lesson from Nvidia’s two surprise downside revenue guidance revisions. In this post, I used management’s perspective to estimate the proper Nvidia’s share price reaction to its guidance changes. The evidence suggests that Nvidia’s shareholders have overreacted to the negative information conveyed by the downside revenue guidance. If just looking at guidance changes alone, Nvidia's shares have been traded at a $40 discount or undervalued by 23%.

Disclosure: I am/we are long NVDA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.