Beware Of Nvidia Mirage of Valuation: When Numbers Disconnect from Reality

From the time it announced earnings, NVDA traded in a range between 450.10 and 746.11. The last price (726.13) is closer to the higher end of range.

Valuation serves as the compass guiding decision-making processes. It is the bedrock upon which investors build their strategies, allocate resources, and assess potential returns. Yet, in the labyrinth of markets, there exists a phenomenon where valuation seems to detach from the very reality it aims to measure.

This disconnect between numbers and actual worth can lead investors down a treacherous path, often culminating in devastating consequences. Valuation, in its essence, is the art of assigning a numerical value to an asset, be it a stock, a property, or a company.

Traditional methods such as discounted cash flow (DCF) analysis, comparable company analysis (CCA), or the price-to-earnings (P/E) ratio, rely on rational assumptions about future cash flows, growth rates, and market dynamics.

In this article, I would like to bring our attention to the Nvidia stock price drop after the very positive earnings release on Nov 2023. Could valuation be one of the reason as these assumptions are not infallible, and when they veer too far from reality, valuation becomes a mirage.

The intrinsic value of NVDA stock under the base case scenario is 427.77 USD. Compared to the current market price of 726.13 USD, NVIDIA Corp is overvalued by 41%.

The intrinsic value of NVDA stock under the best case scenario is 950.6 USD. Compared to the current market price of 726.13 USD, NVIDIA Corp is undervalued by 24%.

The intrinsic value of NVDA stock under the worst case scenario is 332.58 USD. Compared to the current market price of 726.13 USD, NVIDIA Corp is overvalued by 54%.

If we looked at how the intrinsic value stacked up, I would think Nvidia stock price is overvalued, so is Nvidia fundamental metrics being ignored?

One of the most prominent examples of valuation disconnecting from reality is witnessed during speculative bubbles. These bubbles are fueled by irrational exuberance, where investors disregard fundamental metrics and bid up prices based on unrealistic expectations.

The dot-com bubble of the late 1990s and the housing bubble of the mid-2000s are prime illustrations of this phenomenon. In both cases, valuations soared to stratospheric levels, detached from the underlying fundamentals, only to come crashing down with catastrophic consequences.

If we looked at Nvidia last quarter earnings in November 2023, Nvidia share price up a whopping 252% since the opening bell on 3 January. And it gives the tech stock an eye-popping market cap of US$1.25 trillion.

But if we looked at the asset and liabilities for Nvidia, it stands at $54B, around 35% were in cash and investments, both short-term and long-term.

And not forgetting that Nvidia has more than $20B in liabilities, we may argue that a manufacturing company would have more liabilities, but if we looked deeper, we could see that the liabilities is in non-current assets.

If given a scenarios, there will come a time when these assets need to be written off, will the valuation remain high? or the asset will drop right?

The rise of disruptive technologies has further exacerbated the issue of valuation detachment. Companies operating in sectors like biotech, artificial intelligence, or electric vehicles often trade at sky-high valuations despite minimal revenues or profits.

We need to understand that Nvidia is a provider of hardware and software to the Artificial Intelligence hype, while AI might hold immense potential for the future, valuing companies solely based on promises and projections can lead to substantial discrepancies between market value and intrinsic worth.

Nvidia profitability score is high, but question remains whether it will continue to be profitable with competition and new technologies coming?

The influence of market sentiment and herd behavior cannot be overstated in understanding valuation disconnect. In times of euphoria, investors tend to overlook risks and inflate valuations, driven by fear of missing out (FOMO). Conversely, during periods of panic, assets can be undervalued as investors rush for the exits, guided more by emotion than rationality. This herd mentality amplifies market volatility and widens the chasm between perception and reality.

If we looked at how the sentiment was high before Nvidia earnings, but then it actually drop to 64 on 22 Nov 2023 right after its earnings release on 21 Nov. We are seeing similar pattern now, with sentiment score at 75, will we be seeing similar drop after 21 Feb?

As investors, we really need to be aware of what happen if a strong stock does not perform despite having good earnings and profitable, valuation disconnected from reality is a perilous quagmire that ensnares unwary investors and imperils the stability of financial markets.

Only by anchoring valuation in reality can we navigate the turbulent seas of finance with confidence and resilience.

Appreciate if you could share your thoughts in the comment section whether you think Nvidia is overvalued and are we going to see some correction despite anticipation of good earnings?

Disclaimer: The analysis and result presented does not recommend or suggest any investing in the said stock. This is purely for Analysis.