NVIDIA & AMD: Excellent Companies, Volatile Stocks, Cautious Markets
An article that wouldn't get published in a "certain place"
Note: This article apparently didn’t have the type of coverage “followers of these tickers on SeekingAlpha (SA) generally expect from contributors: a deeper dive into supply chain issues, industry catalysts, competitive positioning in end markets, etc”. I stated in response that in the YTD as of Friday (before markets opened), 58% of SA contributors recommended a "Buy" on NVIDIA and 35% recommended a "Hold". 86% recommended a "Buy" on AMD and 13% recommended a "Hold". In the same period, NVDA is down 46.13%, AMD is down 45.13% while the S&P 500 is only down 20.86%. No dice. C’est la vie. So here it is; all data included till Monday (before markets opened).
Both NVIDIA and AMD show excellent line item trends, albeit with a slight downtrend in diluted earnings per share. This early in the FY, this ordinarily isn't a major concern.
What's concerning, however, are both stocks' historical overvaluation that is facing a reckoning this year as growth outlook continues to rationalize.
While it's somewhat unlikely that past performance will repeat itself this year, both are strong companies worthy of consideration with tempered expectations.
Arguably lying squarely in the middle of the "tech" zeitgeist of high-conviction names for many investors is the "hardware tech" space represented by NVIDIA Corporation (NASDAQ: NVDA) and Advanced Micro Devices, Inc (NASDAQ: AMD). Both stocks are also (arguably) among the most watched in the world right now.
Both companies' primary work lies in the design and sale of processing hardware, although NVIDIA is more known for its range of high-performance GPUs while AMD's niche is the more-traditional CPU. While GPUs and CPUs, strictly speaking, are traditionally used together, recent practices involve scaling up computation performance via "chaining" GPUs more often than CPUs.
For possibly this reason, NVIDIA (which had been discussed in my earlier coverage over at SeekingAlpha) tends to be slightly more in the "high-conviction" zeitgeist than AMD for some investors. Overall, though, both companies tend to be "high-conviction" stocks. In both cases, this conviction isn't exactly unearned.
A quick rundown of the past two years' Full Year results versus the first quarter of this year - as per each company's calendar - shows at least partially why either stock is so highly prized. For instance, here are the trends seen in NVIDIA's line items in the current quarter versus the past two years:
In past fiscal years, the trends indicate an all-round positive growth in excess of cost increases coupled with an almost-doubling of earnings per share attributable to common shareholders. In the current quarter, there is a slight indication that while costs and current liabilities are roughly proportional to one-fourth of the previous year's figures, the revenue is a little less than a fourth. Diluted earnings per share, after accounting for a four-for-one stock split executed on July 19, 2021, also trails relative to the corresponding quarter in the previous year.
Beyond a ramping up in long-term debt, there are no particularly egregious differences in trend for either company. In fact, even AMD shows a corresponding decrease in diluted earnings per share.
This decline isn't necessarily a major concern this early in the fiscal year. However, like every other stock - particularly "tech" names - in the year so far, both stocks' price has seen a precipitous fall. The reasons for this is more reflective on the stock's valuation as opposed to the company's.
In their last earnings call, NVIDIA CEO Mr. Jensen Huang stated:
"Demand (for Pro Visualization) remains strong as enterprises continued to build out their employee's remote office infrastructure to support hybrid work."
"Our automotive design win pipeline now exceeds $11 billion over the next six years, up from $8 billion just a year ago."
"Data Center growth was driven primarily by strong adoption of our A100 GPU for both training and inference with large volume deployments by hyperscale customers and broadening adoption across the vertical industries"
"We expect strong sequential growth in Data Center and Automotive to be more than an offset by the sequential decline in Gaming."
In their last earnings call, AMD Chairman and CEO Miss Lisa Su stated:
"We are well positioned to accelerate our growth in commercial notebooks in 2022 based on the expanded number of design wins on track to launch."
"Our focus remains on the premium, gaming and commercial portions of the market where we see strong growth opportunities"
"Looking forward, we see very strong demand across all of the Xilinx end markets and are focused on increasing supply" (author's note: Miss Su was referring to automotive, industrial, vision and healthcare and consumer markets, with some early encouraging results in fintech)
Stock Performance and Trends
Ratio and Volume Analysis
From March of last year through this week, an analysis of the 3 ratios that has been carried out in more recent articles, reveal a few interesting facets:
Note: Data services often don't report ratios that are too high or too low since they're deemed to be meaningless in terms of actionable insight. Days of unreported ratios are represented by a blank here.
Leaving out any comments on the comparison of Price to Book Values due to the absence of the same in AMD's case in most instances, both stocks' Price to Sales (PS) ratios indicate a fair bit of relative stability (albeit, a little more so in NVIDIA's case than AMD). However, the Price to Earnings (PE) ratio - by far the most popular metric for stability evaluation - shows a precipitous decline of nearly 37% over the week preceding June 16th for NVIDIA and 58% in AMD's case.
While high ratios are typically seen in companies with significant invested capital or in those with high growth outlook, lower ratios signify weakening growth outlook or a recognition of the company attaining some semblance of a "steady state" in terms of market share.
In BlackRock Investment Institute's Weekly Commentary dated June 13 presented by Portfolio Strategist Natalie Gill, who represented the panel led by Global Chief Strategist Wei Li, BlackRock's decision to not "buy the dip" in the near term were attributed to three reasons:
The energy crunch will hit growth and higher labour costs in the face of inflationary pressures will eat into companies' profits;
Stock valuations don't show improvement after accounting for lower earnings outlook and faster expected pace of rate rises;
There's a growing risk that the Federal Reserve will tighten too much, making equities less attractive.
Leaving aside the third point, there's an interplay between the first two points: if inflation weighs heavy on the earnings of individuals and corporations alike, what are the likelihoods of an upgrade in "rig" (among the former) or "infrastructure" (among the latter)? Corporations could push back upgrades to improve their earnings while individuals would rather focus on essentials over spending on new tech.
Publicly-traded corporations also find substantial incentive in this environment to buy back shares to prop up future intrinsic stock value by improving earnings per share. Both companies have done that: since May 2021, AMD has allocated a net $12 billion to a stock repurchase program with no termination date while NVIDIA has expanded its 2021-era share buyback strategy to $15 billion through December 2023.
There is also a very different argument as to whether the PE Ratios for long-standing companies should be in the 50s to 70s while simultaneously considering them to be stable in the first place. As the "Equity Trap" article published in February highlighted:
After the mainstay of the U.S. economy shifted from wide-base manufacturing and ancillary services to "tech", the latter has enjoyed substantial investor attention, with commentary and coverage of the "tech" sector leaning heavily on growth potential for investors.
A decade-long exuberance for "tech" stocks after the 2008 Financial Crisis leave them particularly vulnerable to corrections, regardless of current quarterly earnings.
A dramatic growth outlook forever simply doesn't happen in real life. The larger the ratio, the longer this outlook is effectively being imputed, with lesser and lesser grounds for realism.
Given that "tech" stocks have been a hot choice for investors for quite a few years now, this leads to a consideration of traded volumes. Over the year till date (YTD), monthly average volumes have generally been trending down across the board after the customary "January bump". However, when comparing traded volumes in the stocks versus the "tech-heavy" Nasdaq-100 (here represented by the ETF QQQ) normalized relative to volumes seen on the 3rd of January, this overall market trend is a little more complicated:
Overall, there is a very high degree of correlation between volume shifts in the broader ETF and NVIDIA while AMD tends to show a little lag and even a slight degree of non-synchronicity on a number of occasions.
A persuasive attribution for the strong tendency to attempt a bullish rally on "tech" stocks so often (that have nearly always come a cropper shortly thereafter so far) is the tech sector's overall historical sky-high valuations. If so, reality has been biting market participants: there appears to be no strong support for rosy Total Addressable Market estimates, operational efficiency estimates, et al in the face of increasing economic pressure on earnings. The proof is in the pudding and not in a document purporting to be a "cookbook"; one can't eat the latter.
Past Week Performance vs Macroeconomics
Since June 17, both stocks have started a tentative rise that translates to rising ratios on a week-on-week basis:
Over the Year Till Date (YTD), both stocks have heavily underperformed against the broader benchmark S&P 500 (SPX) as well as the "tech-heavy" Nasdaq-100 (NDX):
The underperformance against NDX is indicative of the relative overvaluation these stocks have even within the generally-overvalued "tech" sector. This is further supported by the performance of the stocks versus the NDX over the past two Fridays:
First off, the "tech-heavy" benchmark has seen a stronger recovery than either stock with AMD showing a lower "spring back". As aforementioned, NVIDIA traditionally attracts a higher "conviction" so this is perhaps expected. Secondly, there's a fair-to-strong likelihood that this broad market recovery might not be sustained. Almost the entirety of the week-on-week rise was attributable to Friday's big rally.
The idea that this rally will be sustained has precious few buyers in the industry: Wolfe Research, for instance, noted that this was due to deeply oversold conditions being disposed off (author's note: this is a pretty fair summary for the last few rounds of "Friday bumps" in these stocks as well). Wolfe Research continues to maintain an intermediate-term bearish outlook and states that the next phase would be driven by rising recession risks and downward earnings revisions.
This week will see a host of data being released, including May updates to home sales, the Personal Consumption Expenditures Index, the Purchasing Managers' Index, Eurozone unemployment rates and inflation statistics. Furthermore, first-quarter GDP growth rate is expected to be finalized and the 1.5% contraction in the U.S. economy will be confirmed.
The Street is cautious and for good reason: minute improvements will likely not find a lot of takers for a sustained rally.
Conclusion and Recommendation
For the proponents of these two stocks, two facts need to be taken into consideration:
Wall Street analysts' ratings are derived from the company's balance sheet and financials as opposed to the stock's current valuation. Fund managers and prominent investors have voiced concerns about overvaluation in the U.S. equity market for almost 5 years now.
Overvaluation divorces the stock's performance from the company's, with the latter taking outsized cues from the former in the best of times and finding little purchase in the worst of times.
Companies such NVIDIA and AMD are indeed core to today technologically-driven world and cannot be discarded completely, particularly when considering how strong and orderly the revenue/earnings line items are. Both companies' leadership show commendable discipline and steady commitment to their well-earned core business competence. However, this is separate from the stock's current state; no stock in the world exists in its own bubble, separate from the "herd".
Given the facts and reasoning presented so far, recommendations would necessarily have to be variegated on the basis of investor profile and preference:
For long-term investors, those currently holding either or both stock can consider continuing to hold. However, a reset in expectations over the short- to mid-term would be in order; considering the fact that it took years before the high ratios seen in the past were manifested. There is a fair likelihood that those looking to "buy in" will find more opportunities in the near future at cheaper prices.
Investors looking for inflation-busting gains over this year will likely not find this in either stock. Ordinarily, financials and energy stocks generally do well in such times but most of them are currently still estimated to be oversold.
For disciplined tactical investors in Europe and Asia:
Going forward into the months or quarters of this year, a series of price discovery actions around certain price levels could be expected for both stocks. European and Asian markets have a variety of leveraged/leveraged inverse exchange-traded products (ETPs), Daily Leverage Certificates (DLCs) and "Faktor-Zertifikats" from a number of issuers based on both stocks that offer daily-rebalanced inverse and leveraged factor exposure to price trajectories. However, these products are purely short-term trading instruments from a risk perspective and the fee structures inherent have a wide degree of variance, which merit a once-over for the uninitiated.
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