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Inside NVIDIA’s Rewards versus Risks

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Sep. 27 2017, Updated 10:37 a.m. ET

NVIDIA’s future earnings potential

NVIDIA’s (NVDA) revenue rose 56% YoY (year-over-year), while its operating income rose 191% YoY in fiscal 2Q18. Over the past five years, NVIDIA’s revenue has grown at a CAGR (compound annual growth rate) of 12%, with the majority of the growth coming in fiscal 2017 and 2018.

Assuming that the company maintains this CAGR for the coming five years, investors would not be adequately compensated for the risk they take by buying the stock at its new high of above $185.0.

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Risk of uncertainty

Many analysts describe NVIDIA’s current growth analogy as that of a company selling shovels during a gold rush, and clearly, customers are willingly paying a high price for their products. But there’s a high degree of uncertainty surrounding this growth. How long can it last?

NVIDIA’s stock price growth potential

Evercore ISI analyst C.J. Muse expects NVIDIA’s EPS (earnings per share) to reach $10.0 in the next three to five years, from $3.6 estimated for fiscal 2018. If we take the midpoint, Muse expects NVIDIA’s EPS to reach $10.0 by fiscal 2021 and has therefore set a price target of $250, which represents an upside of 35% from the current trading price of around $185.

A 35% upside in stock price in four years means an average annual growth of nearly 8.8%—not a large reward for the risk.

Risk of volatility

NVIDIA stock is the second-most-volatile semiconductor stock (SMH) after Cypress Semiconductor (CY), with a beta of 1.55, indicating that the stock reacts more aggressively than the market on a particular news. The stock fell 5% on August 11, 2017, after NVIDIA’s data center and automotive revenues missed estimates for fiscal 2Q18.

The high growth in stock price has put NVIDIA in the oversold category, with a 14-day RSI (relative strength index) of 73. A highly volatile stock in the oversold category indicates that the stock could fall when there’s no sufficient news to keep the stock at a high price.

To be sure, traders make some gains by chasing price momentum in the short term, but there’s likely a huge risk once that momentum fades.

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