- The Evergrande crisis hurts Chinese real estate developers and investors primarily, but other industries could also feel an impact.
- Decelerating economic growth in China could impact tech companies like NVIDIA, Apple, etc.
- Overall, Evergrande does not look like it will be a huge issue for NVIDIA, but investors should keep an eye on the situation.
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The Evergrande (OTCPK:EGRNY) debt crisis has begun to impact a wide range of companies that are active in the region. NVIDIA (NASDAQ:NVDA) could feel some headwinds from potential Evergrande fallout as well, although the risks do not seem especially large. Overall, NVIDIA remains a quality company with attractive growth prospects that trades at a pretty high valuation, which could limit its total return outlook.
NVDA Stock Price
Following the recent stock split, NVIDIA is currently trading at $211 per share. This is roughly 10% below the all-time high of $230 that was hit this summer. Still, shares are up by a very attractive 60%+ this year, easily outperforming the broad market. At a market capitalization of $540 billion, NVIDIA is one of the highest-valued chip companies in the world at current prices, trailing only Taiwan Semiconductor Manufacturing Company (TSM).
Analysts have raised their price targets repeatedly and generously this year.
One can argue that this is due to NVIDIA's ongoing strong growth that has beaten past estimates, but others might argue that some analysts have only been increasing their price targets to keep up with NVIDIA's climbing stock price. No matter what, analysts believe that shares are relatively fairly valued today, as the consensus price target of $225 implies an upside potential of just a couple of percentage points over the next year.
Will Evergrande Impact NVDA Stock?
Let's quickly recap the Evergrande situation first. Evergrande, a leading Chinese property developer, has gotten into troubled waters over the last couple of weeks and months, as the company's high debt load of $305 billion could force the company into bankruptcy. Evergrande missed an interest payment a couple of days ago, and it is not known whether the company will be able to make future interest payments.
This does, of course, mostly impact Evergrande as a company, as well as shareholders, employees, bondholders, customers that made down payments for homes, etc. On top of that, there also are other areas that will feel an impact. It is, for example, likely that other property developers will have more difficulties when they want to access new capital, as banks and other lenders will be more conservative when it comes to lending money to these companies. Depending on how the story continues to develop, it is also possible that the Evergrande crisis will lead to a more broad-based downturn for the Chinese economy - after all, real estate makes up more than one-fourth of China's gross domestic product. It is at least possible that the Evergrande fallout will hurt the Chinese real estate market on a wider basis, which could translate into some issues for banks and real estate investors. Chinese politicians are seeking to solve the issues at Evergrande, but a rescue package financed with taxpayers' money does not seem like the most likely scenario. Instead, the Chinese government has started to guide state-backed governments to take over some of the assets owned by Evergrande, which should improve the latter's liquidity.
It may very well turn out that this crisis can be solved without too many issues, but at least for now, the market seems to be wary about the impact this crisis could have on all kinds of companies. Among them is NVIDIA, which has seen its shares come under pressure due to its exposure to the Chinese economy. First, NVIDIA makes significant sales in China, one of the largest economies in the world. A slowdown in Chinese economic growth, which may or may not be caused by the Evergrande crisis, could thus hurt NVIDIA's potential to sell products in the country. On top of that, NVIDIA's chips and graphics cards are manufactured by partners that are, at least in some cases, located in either Taiwan or China. Should the crisis surrounding Evergrande lead to more pronounced regional issues, it is at least possible that the supply chain sees some headwinds.
Overall, I do not think that the risks stemming from the Evergrande situation are overly large for NVIDIA, but there are things that investors should keep an eye on. The fact that NVIDIA's shares have declined by about 10% over the last couple of weeks as the Evergrande situation got into the spotlight is an indication that market participants see some risks for NVIDIA and are pricing those risks into the stock right now. The same holds true for other large-cap tech companies that are dependent on China to some degree, either due to their supply chains or since China is an important end market. This does, for example, hold true for Apple (AAPL), which has, like NVIDIA, been feeling some selling pressure over the last two weeks.
Is NVIDIA Stock A Buy, Sell, Or Hold?
The risks stemming from a potential slowdown in the Chinese economy should not be disregarded completely, but I believe that they also are not the main risk. Instead, the biggest potential headwind for NVIDIA is its pretty high valuation. NVIDIA undoubtedly is a great company, combining strong tech, great execution, visionary management, and a strong balance sheet. A great company is not necessarily a great investment, however, as one should also consider where the valuations are at the time. In NVIDIA's case, the valuation stands at an above-average level right now, which could translate into total return headwinds over the coming years.
Today, NVIDIA Corporation trades at 51x forward net profits, which represents a pretty large premium relative to how its shares were valued over the last decade. The 10-year median earnings multiple stands at 30 today, thus shares trade at a 70% premium to the historic norm. One can argue that NVIDIA's shares have been too cheap in the past and that the 10-year median earnings multiple is thus not very telling. On the other hand, however, one can also argue that the law of large numbers dictates that growth rates will slow down over the years, which should, all else equal, translate into a lower valuation. Whether NVIDIA should be valued at 30x net profits or not, it seems pretty clear that shares are trading at a rather expensive level today - investors get an earnings yield of less than 2% when they buy at current prices. Looking at NVIDIA's enterprise value to EBITDA multiple, which accounts for debt usage and cash on the balance sheet, NVIDIA looks even more expensive today - shares trade at a ~150% premium relative to the long-term norm.
Source: Seeking Alpha
In the above table, we see current growth projections for NVIDIA's earnings per share over the coming years. Following massive growth this year, earnings per share will grow by only ~10% a year in 2022 and 2023. NVIDIA has repeatedly outperformed analyst expectations in the past, and these estimates may thus be too conservative. Even if that is the case, however, it seems pretty clear that NVIDIA will not grow its earnings per share at a massive pace in the coming years. Even if actual earnings per share growth comes in at 15%, or roughly one and a half times as high as what analysts are predicting today, I don't believe that would justify an earnings multiple of more than 50.
NVIDIA has been a great growth investment in the past, but with growing size, maintaining extraordinary growth becomes harder and harder, and eventually, it is impossible to grow at 30%, 40%, or 50% a year. NVIDIA seems to be entering a phase of still very solid, but less exciting growth over the coming years. Paying more than 50x forward profits for a company that grows at a low-double-digit pace does not seem like a great deal to me. NVIDIA is active in a completely different industry than Facebook (FB) or Alphabet (GOOG), but purely in order to show that high growth can oftentimes be bought at way lower valuations, let's look at how these tech companies are valued today:
We see that both Facebook and Alphabet are trading at earnings multiples in the 20s, while they are expected to grow their earnings per share at a 20%+ rate over the coming years. In other words, they are forecasted to grow faster than NVIDIA, and at the same time, they trade at roughly half of the valuation NVIDIA trades at. Tech companies with solid growth rates thus do not at all automatically trade at an earnings multiple of more than 50, which means that there is considerable downside potential for NVIDIA's shares.
I do, for the record, not expect NVIDIA to trade at 25x net earnings anytime soon, but even multiple contractions towards 35x net profits (which would still represent a premium to the historic norm) would translate into a 30%+ share price decline from the current level.
I thus do believe that NVIDIA is a quality company, but that its shares are too pricey today. I do not believe that paying more than 50x forward earnings is justified by the company's near-term growth outlook, as Wall Street analysts currently predict decelerating growth over the coming years.
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This article was written by
Jonathan Weber holds an engineering degree and has been active in the stock market and as a freelance analyst for many years. He has been sharing his research on Seeking Alpha since 2014. Jonathan’s primary focus is on value and income stocks but he covers growth occasionally.
He is a contributing author for the investing group Cash Flow Club where along with Darren McCammon, they focus on company cash flows and their access to capital. Core features include: access to the leader’s personal income portfolio targeting 6%+ yield, community chat, the “Best Opportunities” List, coverage of energy midstream, commercial mREITs, BDCs, and shipping sectors,, and transparency on performance. Learn More.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of FB, GOOG either through stock ownership, options, or other derivatives. 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.
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