NVIDIA Stock: The Bear Argument That "It's Overvalued" Has Big Holes

NVIDIA (NASDAQ: NVDA) stock has returned an amazing 1,090% in the three-year period through June 1, demolishing the S&P 500's 38.2% return.

This naturally leaves many investors wondering, "Is it too late to buy NVIDIA stock?" My opinion is no, it's not. The graphics processing unit (GPU) specialist is benefiting from several enormous trends that are in the early stages, including esports and artificial intelligence (AI), and is also poised to majorly profit when driverless vehicles become legal across the land.

But what about the sizable pack of bears who like to drum (or growl, as bears are wont to do) away that NVIDIA stock is "overvalued" or "overpriced"?

NVIDIA bears' basic "overvalued" argument

Just as there are a fair number of species of bears in the world today (eight to be exact), there are a good number of varieties of the bear thesis that NVIDIA stock is overpriced.

At core, however, most of them seem to go something like this: "NVIDIA is a great company, but its forward price-to-earnings (P/E) ratio is very high at (whatever it's at the time)." Some of the bears use the trailing P/E, while others use both valuation metrics to support their opinion. For the record, NVIDIA stock's trailing and forward P/E ratios are currently 42.9 and 33.2, respectively. (These two metrics are arguably the most commonly used stock valuation metrics. The trailing P/E is calculated by dividing the price of a share of stock by a company's earnings per share (EPS) over the past year, while the forward P/E's denominator uses Wall Street's EPS consensus estimate for the year ahead.)

NVIDIA bears' "overpriced" thesis has big holes

Here are the major issues with the bear thesis that NVIDIA stock is overvalued.

1. The P/E and forward P/E don't take earnings growth into account

These commonly used metrics look at valuation in a vacuum. Metrics that take earnings growth into account are much more useful. One such metric is the PEG, which is a stock's P/E divided by its earnings growth over the trailing 12 months. Many factors come into play, but a general rule of thumb that's applicable to many industries is that a PEG of 1.0 implies that a stock is about fairly valued. While we can't be sure what the future will hold, NVIDIA stock's PEG of 0.43 is encouraging and suggests the stock will prove to be attractively valued at the current price.

2. The forward P/E and forward PEG use estimates, not actual results

The forward P/E is calculated using the consensus among Wall Street analysts for a company's EPS for the year ahead, while the forward PEG also uses the consensus projection for a company's year-over-year earnings growth. There's a big problem with the bears using any metric that's calculated using the Street's projections to support their view that NVIDIA stock is overpriced: Wall Street has a terrible record in estimating NVIDIA's earnings!

3. Wall Street's earnings estimates are likely too low

In the last couple years, NVIDIA has consistently and significantly beat to crushed Wall Street's quarterly earnings estimates. In the last four quarters, for instance, NVIDIA beat analyst consensus EPS estimates by the following percentages (source: Yahoo! Finance):

  • Fiscal Q1 2019: 34.7%
  • Fiscal Q4 2018: 53.1%
  • Fiscal Q3 2018: 41.5%
  • Fiscal Q2 2018: 31.4%

On average, Wall Street underestimated NVIDIA's EPS over the past year by 39.9%! There's no recent improvement in the estimates either, which suggests to me it's very likely NVIDIA is going to continue to sail by the Street's estimates, at least for some time. If this turns out to be true, then NVIDIA stock will prove to be not as pricey as it might currently appear based on valuation metrics that use Wall Street's earnings projections.

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Beth McKenna owns shares of Nvidia. The Motley Fool owns shares of and recommends Nvidia. The Motley Fool has a disclosure policy.