In three recent articles, I discussed how the broader U.S. stock market, specifically the S&P 500 Index, as measured by the SPDR S&P 500 ETF (SPY) is in a classic bubble, then I explained how a traditional 60/40 portfolio is destined to fail because of today's starting valuations, and then I showed a specific example, using two Apple (AAPL) articles, one I authored in May of 2016, and one in August of 2020, to highlight the contrast and differences in valuations today versus four years ago.
Building on this overvaluation narrative, there are a precious few stocks that are more highly valued in the market today than NVIDIA (NVDA) shares, which trade at an incredible 25x price-to-sales ratio and a trailing twelve month price-to-earnings ratio of 91.7, which is significantly higher than the current S&P 500 Index (SP500) price-to-earnings ratio of approximately 29.
In summary, even if NVDA continues to grow like a weed, there is almost no way they can grow into their current valuation today, so investors who have been fortunate to hold what I call this Belle Of The Ball Stock, should at a minimum consider selling a portion of their position today, and more aggressive investors could use a NVDA short position as a hedge for other long positions in their equity portfolio.
Starting Valuations Matter & NVIDIA's Is Off The Charts
NVIDIA Corp. has been one of the preeminent growth stocks of the past 25 years, multiplying investor money in a way that few stocks ever could.
Looking at the chart above, the bull market in NVDA shares has largely paralleled the bull market in growth stocks, which have trounced their value peers for roughly 13 years now.
The fly in the ointment, is that NVIDIA's absolute and relative valuations are off the charts.
According to the valuation table from Morningstar (MORN) above, NVDA shares sport a trailing twelve month price-to-earnings ratio of 91.7, which is rich even compared to NVDA's own elevated valuation history, with NVDA's five-year average price-to-earnings ratio of 42.9. Even more extraordinary, NVDA shares sport a trailing twelve month price-to-sales ratio of 25.8, which historically is nearly impossible to overcome even for the best growth stocks.
Valuation Is Going To Compress
Specific to high price-to-sales multiples, we have to remember what Scott McNealy, the former CEO of Sun Microsystems said about his company trading at a 10x revenue multiple at the peak of the dot-com bubble era.
At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don't need any transparency. You don't need any footnotes. What were you thinking?
Scott McNealy - Business Week 2002
Again, NVIDIA Corp., with a market capitalization of roughly $302 billion, and trailing twelve month revenues of $11.8 billion, is trading for a price-to-sales multiple that rounds up to 26.
Adding to the narratives, revenues have really not grown at a breakneck pace, with 2020 annual fiscal year revenues, which were $10.9 billion, actually declining from 2019 annual fiscal year revenues of $11.7 billion.
Think about those two contrasting facts presented above, which serves to challenge even the rosiest projections of revenue growth for NVIDIA going forward.
Closing Thoughts - Caveat Emptor
It may not seem like it today, however, starting valuations are incredibly important.
With a trailing twelve month price-to-earnings ratio of 91.7, and more importantly, a trailing twelve month price-to-sales ratio of almost 26, there is almost no way that NVIDIA can grow into its $300 billion plus market capitalization.
Morningstar agrees, as they have a $200 fair value target on NVDA shares, even though they assign NVIDIA a narrow moat rating, which suggests downside of roughly 59% from Wednesday, August 19th's, share price of $490.95.
For investors pinning their future hopes on NVIDIA Corp. revenue growth from gaming, data centers, or more specifically, professional visualization, and automotive, which are the real exciting pie in the sky revenue growth opportunities, they need to temper expectations ahead of the company's Q2 2020 earnings results, which are scheduled to be reported today, Wednesday, August 19th, 2020 after the close of business.
Bottom-line, no matter how good the results for NVIDIA Corp. are, and no matter how good the future outlook is, the future is already almost assuredly priced in, even in a best case scenario. This same dilemma applies to the broader equity markets today, which sit at precarious valuation levels, and are poised for a sharp broader market sell-off, amidst a historic capital rotation.